Q1'24 Small Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Small Cap Value strategy (the “Strategy”) returned 3.5%* (3.2%* net of fees) during the first quarter ended March 31, 2024, outperforming the Russell 2000® Value Index (the “Index”) return of 2.9%. For the twelve months ended March 31, 2024, the Strategy returned 25.3%* (24.1%* net of fees) versus the Index return of 18.7%.

The Strategy’s portfolio characteristics can be significantly different from the Index because we primarily invest in smaller, undervalued stocks and adopt a sector-agnostic approach. You can see these distinctions in the charts below.

Size Analysis

During the quarter, the Strategy faced a moderate size bias headwind, where smaller companies in the Index underperformed larger ones. Stocks with a market capitalization below the $827 million Index median saw a return of 1.0%, versus a 3.2% return for stocks with a market capitalization above the breakpoint level. The Index had 14.4% of its weight below the median market capitalization level, while the Strategy had a comparatively higher weight of 50.1%.

Style Analysis

The Strategy benefited from a slight style bias tailwind for profitable companies during the quarter, as stocks with lower PEs outperformed those with higher PEs. Companies with a PE ratio below 15x returned 3.6%, compared to a 2.0% return for those above 15x. However, the tailwind was partly offset by the performance of unprofitable companies (PE ratio below 0x), which trailed slightly behind stocks with a PE ratio below 15x in the Index, posting a 3.4% return for the quarter. The Index carried a weight of 13.2% in unprofitable companies, while the Strategy had a 4.5% weight.

Sector Analysis

The top two contributing sectors to the Strategy’s performance were Consumer Discretionary and Industrials. The Strategy’s overweight in these sectors resulted in a moderate tailwind, further amplified by positive stock selection scores, especially in the Consumer Discretionary sector. The two sectors that most negatively impacted the Strategy’s performance were Financials and Energy. Poor stock selection scores in Financials and the underweight in Energy (the best performing sector in the Index) were the key factors.

Portfolio Characteristics (as of 3/31/24)

Top Contributors

GigaCloud Technology (“GCT”) operates as a B2B logistics firm specializing in linking Asian manufacturers with US and European retailers primarily dealing with bulk merchandise, with a focus on larger household furniture. Shares performed well in the quarter after closing on two favorably valued acquisitions and reporting strong 3Q results. Though it is possible GCT might grow into its current valuation, the odds are not favorable enough for us to continue to hold the company. With a 110% increase in the share price during the quarter, we liquidated our position.

Ultra Clean Holdings (“UCTT”) is a critical subsystem component supplier to many of the largest semiconductor capital equipment companies. Despite a longer than anticipated industry downcycle, both the company and its peers are beginning to see evidence of demand returning as the year progresses. The shares have responded nicely over the past two quarters, pushing toward all-time highs. UCTT stands to benefit from more manufacturing capacity, increasing industry capital intensity for semiconductor manufacturers, and a larger service offering, all of which should lead to increased earnings power.

Caleres (“CAL”) is a long time holding of the Strategy. CAL is a large retailer and wholesaler of footwear in the United States. While the retail footprint is not “mall-based,” there have been concerns that the business would be subject to heavy promotional pricing and a reduction in consumer demand in the coming year. As more positive trends in the footwear industry have emerged, confidence in CAL has grown, leading to an all-time share price high.

Chefs’ Warehouse (“CHEF”) is a distributor of specialty food products to the independent and boutique restaurant industry. Shares were purchased during the COVID period in anticipation of a slowdown in the restaurant industry sell-off.  During the past six months, CHEF’s results have been fairly consistent, but the stock has suffered volatility as concerns about inflation and consumer belt tightening heightened. During the most recent earnings call, management indicated that concerns about a substantial business downturn were exaggerated, and the shares rebounded from the fourth quarter sell-off.

Sterling Infrastructure (“STRL”), a provider of highway construction and site development services, reported strong fourth quarter results that capped off a record year. End markets continue to be healthy, supported by favorable funding momentum for its construction services and steady demand for new manufacturing facilities and data centers. Year-end backlog grew 40%, with good visibility into 2025. STRL generated over $13 per share of free cash flow during 2023, providing the company ample liquidity to fund additional acquisitions.

Top Detractors

Metropolitan Bank Holding (“MCB”) is a business bank based in Manhattan, New York. The company has been the subject of controversy over the last year. Hedge funds and short sellers have tried to link MCB to the issues faced by other banks that have undergone turmoil. The recent stress experienced by New York Community Bancorp (“NYCB”) was the latest example of this unrest. MCB trades at only 6x ’24 estimates, has plenty of capital, and remains highly profitable.

ConnectOne Bancorp (“CNOB”) is a community bank based in northern New Jersey. The stock gave up some recent gains following a strong rally during the fourth quarter amid concerns that the Fed may delay anticipated rate cuts this year. The bank specializes in lending against commercial real estate, a vertical that has received particular attention with the recent rise in rates. The bank should be near a trough in earnings and realize significant earnings growth if we see an upwardly shaped yield curve again.

Global Medical REIT (“GMRE”) is a real estate investment trust (REIT) that focuses on healthcare properties in secondary markets. The REIT industry has been pressured by the rapid rise in interest rates because acquisition activity has slowed and management teams have struggled to raise additional capital. As borrowing rates decline, so should cap rates, leading to better valuations for REIT stocks.

Comtech Telecommunications (“CMTL”) is a key provider of next-generation 911 (NG911) emergency systems sold to municipalities and a provider of highly secure wireless communication systems. The stock experienced a sharp decline following a recent unexpected CEO change caused by an undisclosed non-business-related issue. This led to delays in the filing of CMTL’s 10Q (now current) and debt refinancing efforts. Recent results show that the backlog is still strong and slightly growing, and defense spending on CMTL as part of a recent US government funding bill should help future revenues.

Bridgewater Bancshares (“BWB”) is a community bank based in the suburbs of Minneapolis, Minnesota. The stock traded down during the quarter after a strong rally during 4Q23, driven by concerns of delayed Fed rate cuts. With nearly all of its revenue coming from spread income, its margins are very sensitive to interest rates and the slope of the yield curve. Despite being highly profitable, the bank continues to trade at a discount to tangible book value.

Market Outlook

Even in the face of a persistently inverted yield curve and ongoing inflation concerns, the US equity markets have reached record highs. At its second meeting of the year in March, the Federal Open Market Committee (FOMC) held the federal funds interest rate within the current target range of 5.25% to 5.50%, while projecting three rate cuts before the year end. The FOMC must time their rate cuts carefully. Any miscue could lead to a rise in unemployment and credit deterioration.

So far, the U.S. economy has been growing at a solid pace with a resilient labor market. The final result for fourth-quarter GDP showed an increase to 3.4%, above the second preliminary estimate of 3.2%. Looking ahead, while the overall projection for 2024 GDP is expected to decline to 2.1%, the trend is still positive. In March, the Institute for Supply Management’s PMI for manufacturing experienced growth for the first time in 18 months, reaching 50.3% compared to February’s 47.8%. Also, the services sector continued its expansion for the fifteenth consecutive month, registering 51.4% in March, albeit at a slower pace than February’s reading of 52.6%.

In February, the core PCE Index, which excludes food and energy, remained steady at 2.8%, matching January’s figure but still surpassing its long-term target of 2.0%. The Labor Department reported that the economy added 303,000 non-farm jobs, which accounts for approximately 80% of the U.S. workforce, surpassing expectations set at 205,000. The unemployment rate declined from 3.9% to 3.8% compared to the previous month. Additionally, U.S. wages experienced a 4.1% year-over-year increase in March, marking a decrease from the 4.3% growth observed in February.

The market outlook for this year reflects cautious optimism, as recent economic growth has been sustained in spite of a persistently inverted yield curve. The key driver of economic and market performance in 2024 is likely to be how well the Federal Reserve balances the risks to inflation, interest rates, and the economy. We keep a close eye on leading indicators that could potentially suggest a long-awaited downturn in employment or economic activity. Large-cap tech stocks have been a significant beneficiary of the market rally over the past several years. Should the economy and markets weaken, investors may become less speculative and more valuation sensitive. Presently, the Russell 2000 Value is trading at a price-to-earnings ratio (PE) of 12.6x for the next fiscal year, whereas the S&P 500 is trading at 21.8x PE for the same period. This significant discount of approximately 40% in small-cap value stocks makes them an attractive investment option with a history of strong long-term performance.

PRCP GIPS Report

*Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.

Disclosures

Pacific Ridge Capital Partners, LLC (“Pacific Ridge”, “PRCP”, or “the Firm”) is a 100% employee-owned investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of 1940. The Firm was established in June 2010, and has one office located in Lake Oswego, Oregon. Pacific Ridge claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Pacific Ridge has been independently verified for the periods June 10, 2010 through December 31, 2023. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The Small Cap Value composite has had a performance examination for the periods June 10, 2010 through December 31, 2023. The verification and performance examination reports are available upon request.

The Small Cap Value composite was created and incepted on August 1, 2010. The Small Cap Value composite comprises fully discretionary portfolios managed by the Firm invested primarily in an equity portfolio of small companies with market capitalizations similar to those found in the bottom three-quarters of the Russell 2000® Index. Smaller capitalization equities have historically had greater volatility than large capitalization equities. The Strategy ascribes to a disciplined bottom-up fundamental selection process with an emphasis given to the cash flow generating capabilities of a company. The Strategy’s objective is to outperform the Russell 2000 Value Index which is used as our benchmark. Eligible portfolios must be managed for a full calendar month prior to inclusion in the Small Cap Value composite. Composite dispersion is measured using an asset weighted standard deviation of gross returns of the portfolios included for the entire year. Returns and asset values are stated in US dollars.

The Russell 2000 Value Index measures the performance of the Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. For comparison purposes, the Index is fully invested, which includes the reinvestment of income. The return for the Index does not include any transaction costs, management fees or other costs. It is not possible to invest directly in the Index.

Sources: Pacific Ridge; FactSet Research Systems (“FactSet”); and Russell Investment Group (“Russell”) who is the source and owner of the Russell Index data.

Returns for the Small Cap Value composite are time-weighted and presented gross and net of management fees and other expenses and includes realized and unrealized gains and losses, cash and cash equivalents and related interest income, and accrued based dividends. Net returns are calculated by deducting the highest annual management fee of 1.00% from the quarterly gross composite return. Performance-based fees are available upon request. All returns are calculated after the deduction of the actual trading expenses incurred during the period.

The fee schedule for separately managed accounts is a flat rate of 1.00%.

The portfolio characteristics, sector weightings and attribution analysis for the Small Cap Value composite are based on a representative account within the Strategy. The representative account statistics are shown as supplemental information. The Firm maintains a complete list of contributors and detractors to portfolio return as well as a complete list and description of composites and pooled funds, policies for valuing portfolios, calculating performance, and preparing GIPS Reports, all of which are available upon request by contacting Peter Trumbo, Chief Operating Officer/Chief Compliance Officer at (503) 886-8972 or Peter.Trumbo@PacificRidgeCapital.com.

GIPS is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Top and Bottom Performing Securities represent those security holdings that had the largest positive and negative total contribution to the portfolio return for the quarter. Top and Bottom Economic Sectors represent those sectors that had the largest positive and negative total contribution to the portfolio return. The holdings identified do not represent all the securities purchased, sold or recommended to clients.

In order to maintain consistency when comparing the Small Cap Value strategy to the Russell benchmark, the Firm utilizes FactSet’s outlier methodology calculations which provide a comparable portfolio characteristic calculation methodology as Russell applies to its indices.

The information provided should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in our Strategy at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any of the holdings discussed herein were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Past performance is no guarantee of future results.

Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.