Q2'22 Small Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Small Cap Value strategy returned -11.7%* during the second quarter ended June 30, 2022, outperforming the Russell 2000® Value Index (“Index”) return of -15.3%.

The strategy’s portfolio characteristics can be significantly different from the Index because we generally invest in smaller-sized and lower-valued stocks, as well as being sector indifferent. This difference is depicted in the charts below.

Size Analysis

The strategy faced a modest size bias headwind during the quarter as larger companies in the Index outperformed smaller companies. Those with a market capitalization above the $946 million Index median posted a -15.1% return, versus a -16.4% return for stocks with a market capitalization below the breakpoint level. The Index had 86.5% of its weight above its median market capitalization level and 13.5% below that level.

Style Analysis

The strategy benefitted from a moderate style bias tailwind during the quarter as unprofitable companies in the Index significantly underperformed profitable ones. The strategy held 4.5% in stocks with forward PEs lower than 0x compared to 9.7% in the Index. The strategy also benefitted from a moderate style value bias tailwind by owning 70.5% in profitable stocks with PEs 0 - 15x. These benefits were offset to some degree by the strong relative performance of shares with PEs > 15x in the Index.

Sector Analysis

The top two contributing sectors to the strategy’s performance in the quarter were Information Technology and Consumer Discretionary, with a combined benefit of nearly 280 basis points. These two sectors were overweight compared to the Index, resulting in a slight headwind that was more than offset by stock selection effect. The top two sector detractors were Financials and Utilities, combining for just over 180 basis points of headwind. There was a very small negative impact from being underweight in Financials, which perfomed better than other sectors in the Index. This negative impact was amplified by poor stock selection in the sector.

Portfolio Characteristics (as of 6/30/22)

Top Contributors

Caleres, Inc. (“CAL”) operates the “Famous Footwear” retail shoe stores and sells its own branded footwear portfolio to third party retailers. Brands owned by CAL include Sam Edelman, Allen Edmonds, Vionic, and Franco Sarto.  The shares have performed very well this year, as consumers re-establish buying patterns and retailers restock shelves. CAL is exceeding pre-COVID performance levels in both sales and profit margin.

Photronics, Inc. (“PLAB) is the leading merchant manufacturer of photomasks used in the production of semiconductors and flat panel displays. PLAB reported another good quarter of strong earnings results and management’s outlook was positive. The company is reaping the benefits of several years of heavy spending on capacity expansion, an investment that is now timely given the shortages in the semiconductor market. Despite a nice move in the shares, the valuation remains attractive and the balance sheet has ample cash reserves.

Chef’s Warehouse, Inc. (“CHEF”) is a consolidator of food product distribution to the boutique restaurant market. CHEF has a very long history of operations and used the last several years to purchase smaller competitors. As consumers return to restaurant spending, CHEF has seen its sales balloon and profit margins increase. CHEF is exceeding pre-pandemic sales and profit levels as has expanded its geographic footprint across the US.

Resources Connection, Inc. (“RGP”) is a provider of temporary staffing solutions, primarily in the finance and accounting industries. The stock is performing well this year despite market headwinds, thanks to management efforts to transform the business and drive sustained revenue growth. Pipelines remain strong and widespread wage inflation is expected to provide a tailwind to profit margins.

Ennis, Inc. (“EBF”) is a manufacturer of business forms and other printed products. The company reported strong results for their quarter ending on May 31, driven by rebounding customer demand. Sales and margins also benefited from recent price increases to cover inflationary costs, resulting in the highest quarterly earnings in over ten years. Supported by its cash-rich balance sheet, we expect EBF to continue its strategy of industry consolidation.

Top Detractors

Shyft Group (“SHYF”), a manufacturer of commercial vehicles, reported first quarter earnings results that were in line with previously-slashed expectations. The company is caught in the unenviable position of very strong demand hampered by an extraordinarily clogged supply chain. While the supply of chassis appears to be improving, the greater level of uncertainty to deliver on record backlog has pressured the shares.

TrueBlue, Inc. (“TBI”) is a market leader in staffing services in the blue-collar/on-demand space. Shares reacted negatively despite very strong first quarter results. The market seemed preoccupied with below-expectation results during the month of March, despite a return to stronger performance in April. As with other staffing providers, TBI is unable to keep up with demand given the tight labor market. TBI recently announced the dismissal of its CEO due to conduct not related to financial performance. Steven Cooper, the Chairman and former CEO, returned to the role.

Heritage Insurance (“HRTG”) is a property and casualty insurer. The company reported another disappointing quarter of earnings for Q1 2022. HRTG booked significantly higher reserves than expected due to a rise in weather-related losses. HRTG already had geographic exposure within Florida. Because of diversification initiatives over the past several years, the company now has additional exposure along the East Coast. The company is targeting an ambitious return on equity goal for 2023 of more than ten percent.

Metropolitan Bank Holding (“MCB”), a community bank based in New York City, sold off sharply during the quarter, along with several of its competitors. MCB has some minor business lines with exposure to cryptocurrencies and online banks that likely contributed to the sell-off. The bank remains highly profitable with excellent credit quality, and should benefit from an expanding net interest margin over the next several quarters.

Ultra Clean Holdings, Inc. (“UCTT”) is a developer and manufacturer of critical subsystems in the semiconductor capital equipment industry including gas-delivery panels. Shares were negatively impacted because of recession concerns and supply chain challenges. While these factors may cause near-term growth headwinds, UCTT remains highly profitable. The company is a key component supplier to manufacturers such as Applied Materials and Lamb Research, whose products will be in high demand as semiconductor manufacturing capacity ramps up worldwide.

Market Outlook

Stock market returns for the first six months of 2022 went into bear market territory for the second time since the pandemic. Growth stocks posted steeper losses than value stocks because of rising interest rates. Since March, the Federal Reserve raised its benchmark federal funds rate three times, from 0% to a range between 1.5% and 1.75%, including a 75 basis point rise in June—the largest increase in twenty-eight years.

This is also the first time in forty years that both bonds and stocks posted losses in two consecutive quarters.  Heading into the second half of 2022, most investors are concerned about slowing economic growth and the threat of recession.

We continue to have a modest growth outlook for the US economy, though supply chain disruptions, inflationary pressures, and rising interest rates have led to a slowdown in the near-term. GDP was -1.6% in the first quarter, driven by decreased personal consumption and private inventory investment. A rise in Covid cases that triggered restrictions in parts of the US also hindered GDP. Expectations for GDP growth in the second quarter is forecasted at -2.0% on further deterioration of private domestic investment.

While sentiment amongst purchasing managers remains positive (the June 2022 US manufacturing PMI reading is at 53.0, the twenty-fifth consecutive month of expansion), several sub-components have weakened. For example, New Orders contracted after a 24-month run because of higher prices and extended lead times. However, for the month of June, the Labor Department reported that non-farm payrolls rose by 372,000, exceeding the 268,000 that economists had expected. Unemployment also remained at 3.6%, in line with estimates. Finally, the pace of deliveries has improved since last year, a sign that supply chain bottlenecks may be easing. These indicators show that the market outlook is mixed, supporting our forecast of modest economic growth.

PRCP GIPS Report

*Information is not statistically meaningful due to an insufficient number of portfolios in the composite for the entire year.
**Information is not statistically meaningful due to an insufficient period of time (36 months).

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 March 31, 2022. 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 March 31, 2022. 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. 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.

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 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 management fee schedule and total expense ratio for the Small Cap Value Fund, which is included in the composite, are 1.00% on all assets and 1.25%, respectively, as of the most recent audit. Total fees for the fund may not exceed 1.25% annually.

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.