Q4'23 Small Cap Value Strategy

Performance Review

The Pacific Ridge Capital Partners Small Cap Value strategy (the “Strategy”) returned 20.5%* (20.2%* net of fees) during the fourth quarter ended December 31, 2023, outperforming the Russell 2000® Value Index (the “Index”) return of 15.3%. For the twelve months ended December 31, 2023, the Strategy returned 19.9%*(18.8%* net of fees) versus the Index return of 14.6%.

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 received a moderate size bias tailwind, where smaller companies in the Index performed better than larger ones. Stocks with a market capitalization below the $730 million Index median saw a return of 17.8%, versus a 14.8% return for stocks with a market capitalization above the breakpoint level. The Index had 14.8% of its weight below the median market capitalization level, while the Strategy had a comparatively higher weight of 54.7%. Moreover, the Strategy achieved positive stock selection scores in stocks with a market capitalization above and below the median level, contributing to the overall tailwind.

Style Analysis

The Strategy benefitted from a modest style bias tailwind for profitable companies during the quarter, as stocks with lower PEs outperformed those with higher PEs. Those with a PE ratio below 15x had a return of 15.6%, versus a 12.9% return for those companies with a PE ratio above 15x. However, the tailwind was offset by the performance of unprofitable companies (PE ratio less than 0x) that posted the best return in the Index during the quarter at 18.1%. The Index had a 14.3% weight in unprofitable companies, while the Strategy had an 8.2% weight.

Sector Analysis

The top two contributing sectors to the Strategy’s performance were Financials and Energy. While the Strategy’s weighting in Financials was almost the same as the Index, its positive stock selection scores generated a substantial tailwind. Conversely, the Strategy benefitted from a moderate tailwind by underallocating the negative-performing Energy sector. The two sectors that most negatively impacted the Strategy’s performance were Health Care and Industrials. The absence of exposure to the Health Care sector, which was among the top performing sectors, resulted in a modest headwind. Furthermore, despite both the Strategy and the Index exhibiting nearly identical returns in the Industrial sector, the Strategy’s overweight position within this sector had a minor negative effect.

Portfolio Characteristics (as of 12/31/23)

Top Contributors

Customers Bancorp (“CUBI”), a Pennsylvania-based community bank, continued its rebound during the fourth quarter as the company surpassed the market’s expectations around yield expansion and its ability to hold deposit costs relatively low. CUBI has demonstrated a relatively stable deposit base since Silicon Valley Bank’s failure. As the bank’s shares approached our calculated value, we began trimming our position during the quarter.

Metropolitan Bank Holding (“MCB”) is a community bank based in Manhattan, NY. MCB came under significant pressure earlier this year during the March banking crisis due to claims that the bank had similar risk factors as other recent bank failures. Following a third straight quarter of clean operating results without any notable deterioration in the fundamentals, the stock rallied significantly higher to close out the year. We trimmed some weight late in the quarter once it became the largest position in the portfolio.

SP Plus (“SP”), a provider of parking management, ground transportation, and baggage handling services, is being acquired by a private strategic player in an all-cash deal priced at a premium over 50%. We feel the valuation multiples are fair and the union will be a good fit given both parties’ focus on utilizing technology to automate the industry.

Photronics (“PLAB”) is the leading merchant manufacturer of photomasks used in the production of semiconductors and flat panel displays. After the shares declined in the previous quarter on industry and US/China trade concerns, a significant rebound occurred, driven by quarterly results and a relaxing of trade worries. With a leading market position, solid ongoing unit-driven demand expectations, strong balance sheet driven by strong ongoing cash flow, and an attractive valuation, PLAB remains a large holding.

GigaCloud Technology (“GCT”) operates as a B2B logistics firm specializing in linking Asian manufacturers with US and European retailers. Shares performed well in the quarter after realizing a temporary pullback from a short report that took numerous liberties regarding the authenticity of the company’s business model and accounting. In addition to the strategic acquisition of a major US furniture retailer at an attractive valuation, GCT reported substantial free cash flow for the most recent quarter and year-to-date. As a result, the share price exhibited a strong rebound during the quarter.

Top Detractors

Designer Brands (“DBI”) is a shoe retailer under the DSW brand and a shoe wholesaler with several popular names in its brand portfolio. While a large contributor to performance in the last reporting period, the stock sold off during the fourth quarter after the company lowered its guidance for the remainder of the year and signaled uncertainty about the next few quarters. Despite the gloomy near-term outlook, shares are trading at a sizable discount compared to the long-term fundamentals and peer multiples, indicating a potential undervaluation.

Great Ajax (“AJX”) is a mortgage REIT that was scheduled for acquisition by Ellington Financial (“EFC”). That deal was terminated in October near the recent peak in treasury yields. Because the company generally holds mortgages on its balance sheet, the market value of these assets declined over the course of the year as interest rates rose. When rates subsequently fell during the quarter, the stock recovered. The Board has hired an investment bank to review potential strategic alternatives, which may include the sale of the company to another entity. Should AJX remain independent, profitability is likely to improve steadily as the Fed begins to implement rate cuts.

DMC Global (“BOOM”) a diversified manufacturer of oilfield service equipment and architectural building products, continues to report improved financial results, but its latest quarter fell slightly below expectations. Weakness in the building products group and lower oil and gas well completions caused revenue to fall for the first time in over two years. The sharp oil price pullback and the negative energy sentiment also likely pressured the shares. Margins remain healthy, however, and will be aided by recent investments in automation and productivity projects. Free cash flow has been strong, enabling the company to pay down a significant amount of debt over the past several quarters.

Matrix Service (“MTRX”), a provider of engineering, construction, and maintenance services to support critical energy infrastructure, had its share price pull back after it was one of the stronger performing stocks in the prior quarter. The company reported mixed September quarter results but continues to win a significant number of new projects that provide optimism for a continued turnaround.

Shyft Group (“SHYF”), a manufacturer of commercial vehicles, reported better than expected earnings in its latest quarter but continues to be plagued by the sharp slowdown in demand for delivery vehicles. However, total orders increased sequentially for the first time in several quarters, which could signal an upturn. There is also a significant opportunity for the company’s proprietary electric delivery vehicle expected to launch this year. Despite substantial investments in growth over the past few years, the balance sheet has remained stable.

Market Outlook

In 2023, market volatility surged due to rising interest rates and persistent global supply chain issues. Among the standout performers for the year were the dominant large-cap technology stocks. However, a shift occurred in the final quarter as small-cap stocks outperformed large-caps by a significant margin. This change coincided with the 10-year Treasury yield dropping to 3.9% from its peak of 5.0% in October. Notably, smaller regional banks presented a promising investment opportunity during this period, while the energy sector stood out as the sole contributor to negative returns.

The core PCE Index, excluding food and energy, exhibited a substantial decline to 3.2% in November, down from 4.9% in December 2022. This decrease was mainly attributable to supply chain improvements. Despite consistently adding over 200,000 jobs per month throughout 2023, the unemployment rate, starting at a historic low of 3.4% in January, rose slightly to 3.7% by December. Although the job market initially appeared strong, the concentrated job growth in specific industries suggested a potential slowdown in the broader labor market.

While the final third quarter GDP dipped slightly to 4.9% from its initial reading of 5.2%, forecasts for the fourth quarter indicated a significant growth slowdown, with an estimated GDP of 1.0%. Overall, the 2023 GDP is anticipated to settle at 2.5%. In December, the Institute for Supply Management’s PMI dropped to 47.9 from 49.8 in September, signaling a possible downturn in manufacturing. Conversely, the Services PMI maintained resilience, consistently reporting expansionary figures since February, reaching 51.3 in December and surpassing September’s 50.1 reading.

As we approach 2024, anticipation of increased stock market volatility looms large as investors await cues from the Federal Reserve regarding the timing of the first rate cut of the year. The Fed intends to uphold the benchmark federal funds rate between 5.25% and 5.5%, marking a 23-year high, until they observe definitive signals of a stabilizing job market and wage growth. In this uncertain climate and muted growth, companies boasting robust balance sheets and high profitability are well-positioned to thrive.

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 September 30, 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 September 30, 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.