Pender’s Dave Barr finds big growth in under-the-radar small-caps

06-04-2019
Pender’s Dave Barr finds big growth in under-the-radar small-caps

FundGrade A+® Award winner

 

Despite recent jitters, the markets have had a great run-up since the meltdown of 2008-09, with the S&P/TSX Composite Index still more than double its low of 7,567 in 2009. The picture hasn’t been as rosy for small/mid-caps, though – the BMO Canadian Small Cap Index rose just 5.7% in the 10-year period through April 30, 2019, and lost 2.4% during the most recent five years. But some funds thrive when others languish. The multi-year FundGrade A+ Award-winning Pender Small Cap Opportunities Fund, managed by Pender’s David Barr, is one such fund.

To the end of April, Pender’s small-cap offering has posted an average annual compounded return of 15.8% since inception in June 2009, and yielded a still-robust 11.0% annualized 5-year return. In all, this fund’s value has almost quadrupled since inception.

So what’s been the problem with small caps (which usually outperform the broader market), and how has Pender excelled by such a big margin?

“Stocks are up, but it’s just a few big companies that have been driving the indexes,” says David Barr, the Vancouver-based fund’s portfolio manager. “Among small- and medium-cap companies, a lot of them are not benefitting from the rise. Everybody is putting their money into cannabis right now, for example, and that’s created a void for real growth opportunities.”

Barr has avoided the fate of most of his peers through astute stock selection, along with a healthy dose of forebearance. “Firstly, you have to be patient,” he says. “We sometimes have a high level of cash – it can be up to 38% to 39% at times, although right now it’s 4%. You need to maintain flexibility, so you can move quickly when opportunities do arise.”

On stock selection, Barr looks for value, but the focus is really on growth. “We are very much bottom-up stock pickers, and we have to use value metrics [in our analysis]” he says. “We look for growth companies, high quality businesses that can drive superior returns over the long term.

“When we look for an analytical edge, we tend to look at smaller companies because that market is less efficient,” Barr adds. “If everybody had perfect information, there wouldn’t be any advantage, but with smaller companies in particular, there are fewer people watching, so there’s more opportunity for mispricing.”

As an example, Barr cites Vancouver-based Diversified Royalty Corp., the fund’s largest holding at 4.7% of total assets. “They buy the royalty rights from national retailers, and their business model creates tons of cash flow,” he says. “Mr. Lube is their largest holding, and they own the rights to Air Miles and The Sutton Group among others.

“We like it because it’s a highly scalable business, and they have a proven, disciplined capital allocator in CEO Sean Morrison.” Barr adds. “He’s made several transactions, and we like what he’s done on the buy as well as the sale side. But the company is misunderstood because the dividend is higher than their free cash flow. They just made another purchase, though, and when that is factored in, then the dividend will not be higher than free cash flow.”

Barr also seeks out special situations, opportunities where businesses can be purchased at a discount to intrinsic value, pointing to Air Transat (recently purchased by Toronto-based venture capitalist Onex Corp.) as an example. “They had $12 per share in free cash, and the shares were trading at $6, so they became a really attractive target for a takeover,” Barr says, adding, “If they had just paid the cash out as dividends, we would have doubled our money. Our view was that someone was going to buy them, and it happened.”

So, while the broader markets took a tumble in May, Barr is undeterred. “We see a lot to do outside the indexes, even more so in Canada. There aren’t a lot of people in our sandbox right now, and we’re seeing a lot of opportunities. But the first thing is to be cautious and have protection on the downside.”

Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.

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