QSV Equity Investors, LLC
Q2 2021 Commentary
More information including a since-inception performance for each of the strategies may be found at www.qsvequityinvestors.com.
Further reopening of the U.S. economy fueled robust economic growth and rising markets during the quarter. In just five memorable quarters, we have gone from a severe economic contraction and uncertainty to rapid recovery and increasing optimism. Estimated GDP growth of 9.4% for the second quarter buoyed this optimism and likely represents a peak before we return to more normal rates of growth. The near-term “voting machine” of the markets has propelled the stocks of cyclical companies tied to the recovery, companies with limited or no earnings, and those that rely on cheap liquidity. To a degree, this is understandable, as many of these stocks had been trounced in the downturn of early 2020, but QSV believes there is merit to focusing on businesses that possess pricing power and sustainable business models for the days ahead.
QSV Strategy Quarterly Performance
The QSV Quality Value Smallcap Strategy returned 2.97% and 2.83%, gross and net of fees, lagging both the Russell 2000 Value and Russell 2000 Indexes’ returns of 4.56% and 4.29%, respectively. Stocks of “QSV-like” businesses, those with less sensitivity to economic and credit cycles and with more sustainable business models, lagged more cyclical and higher beta stocks during the period. This was reflected in the nearly 500 basis points of outperformance posted by the Russell 2000 Dynamic (higher beta) Index relative to the returns of the Russell 2000 Defensive Index that contains businesses with higher Returns on Assets, lower leverage, and lower volatility. At a sector level, Utilities and Real Estate helped performance, while Communication Services and Healthcare hurt performance. Virtually all of our underperformance in Communication Services (and approximately one-half of QSV’s underperformance relative to the Index) was due to the contribution to the Index from meme stock AMC Entertainment that rose 455% in the quarter.
Quality Value Smallcap Top Contributors
Shares of National Storage Affiliates Trust (NSA) rose during the quarter as occupancy rates remained high. Self-storage REITs are operating in an increasingly strong environment, where extremely high occupancy levels along with strong demand are pushing the rates charged to new customers higher while existing customer rent increases are at high single to low double-digit levels. The acquisition of 23 properties also contributed to NSA’s growth during the quarter.
Lemaitre Vascular (LMAT) sales were impacted by a lower number of vascular procedures during the pandemic, yet LMAT continues to demonstrate strong business performance. LMAT engages in the design, sales, service, and technical support of medical devices and implants for the treatment of peripheral vascular disease. LMAT estimates it supplies over half of the 15,000 vascular surgeons and 4,500 hospitals worldwide. A competitive advantage is its focus on niche markets; LMAT has over 15 product lines where it maintains a #1 or #2 market share. This niche focus helps the business resist reimbursement pressures and generate an average return on invested capital of 14% over the last five years. The company’s new product pipeline will support strong future growth.
Quality Value Smallcap Top Detractors
Emergent BioSolutions (EBS) was the largest detractor to returns during the quarter. EBS is a leading maker of vaccines and other products that address public health threats. Quality control came into question at one EBS plant and 75 million doses of the Johnson & Johnson coronavirus vaccine produced there were destroyed because of suspected contamination. The company is also being investigated over allegations that they leveraged government contacts to win the vaccine production business and whether federal officials failed to oversee the firm’s work. QSV exited its position in EBS and will continue to monitor the company.
PaySign, Inc. (PAYS) shares were down during the quarter as the headwinds of the COVID pandemic on the company’s plasma business continued. PAYS has cited pandemic-related government stimulus programs and the current $300 weekly Federal unemployment aid payments (on top of state unemployment benefits) as disincentives for individuals to donate plasma. Revenues in the plasma segment were down 27% in Q1 2021 and headwinds are expected to continue into Q3. In spite of these challenges, QSV believes PAYS will remain strong in this segment where it intends to add a total of sixty new plasma centers in 2021, exiting this year with at least 400 centers, a growth rate of 18% over 2020. PAYS shares sell at a significant discount to QSV’s estimate of intrinsic value. QSV added to its position on weakness in the share price.
Quality Value Smallcap Portfolio Activity
Positions added during the quarter included Evertec, Inc. (EVTC), a payment processing and information technology consulting firm, workforce solution provider Insperity, Inc. (NSP), and food packaging company Karat Packaging, Inc. (KRT). Also added were Leslie’s, Inc. (LESL), the largest direct-to-consumer provider of pool and spa care services, and Zynex Inc. (ZYXI), a medical device manufacturer specializing in pain management products. In addition to the previously mentioned sale of EBS, QSV exited positions in firearms manufacturer Sturm Ruger & Co. (RGR), and Valmont Industries (VMI). NIC Inc. (EGOV) exited the portfolios as it was acquired by Tyler Industries.
The QSV Quality Value Midcap Strategy returned 6.75% and 6.50%, gross and net of fees, for the quarter, leading the Russell Mid Cap Value Index return of 5.66% while lagging the Russell Mid Cap Index return of 7.50%. Security selection helped performance in the Consumer Discretionary and Technology sectors and detracted from performance in the Materials sector.
Quality Value Midcap Top Contributors
Pool Corporation (POOL) was the top contributor to performance during the quarter. As the largest distributor of swimming pool supplies in the world and a leading distributor of landscape and irrigation products, POOL saw strong tailwinds during the shelter in place environment of the pandemic. We expect those positive trends to continue supported by the company’s large installed base of customers and the trend toward de-urbanization.
Index and portfolio analytics provider MSCI Inc. (MSCI) contributed to performance as shares were propelled by the growing adoption of environmental, social and governance (ESG) investing, which the company sees as a $3.9 billion revenue opportunity. Indexes provided by MSCI are an embedded part of a growing number of investment products, including exchange traded funds, and account for 75% of the company’s operating profits. The company produces 20% returns on invested capital and these “sticky” streams of revenue should support strong continued results.
Quality Value Midcap Top Detractors
Casey’s General Stores, Inc. (CASY) dropped nearly 10% during the quarter, detracting from performance. The operator of 2,200 convenience stores completed the purchase of the 94 store Bucky’s Convenience Stores chain. Business performance remains strong and CASY produced same store sales growth during the quarter in each of its business segments. CASY benefits from a geographic competitive advantage, as it is often the only store within miles of its competitors, and it owns 99% of its stores.
Quality Value Midcap Portfolio Activity
No new positions were initiated during the quarter nor were any positions sold in the Quality Value Midcap Strategy.
The QSV Select Value Strategy returned 4.31% and 4.09%, gross and net of fees, lagging the returns of 5.00% and 5.44% for the Russell 2500 Value and Russell 2500 Indexes, respectively. Select Value is a high conviction strategy that takes QSV’s “best ideas” from its Quality Value Smallcap and Quality Value Midcap strategies. Stock selection in the Consumer Discretionary and Financials sectors aided returns, while selection in the Materials and Information Technology sectors detracted. As with QSV’s Quality Value Smallcap strategy, robust returns of more cyclical small cap businesses created headwinds for Select Value, particularly the outsized returns within the Index of AMC Entertainment.
Select Value Top Contributors
National Storage Affiliates (NSA) and Pool Corporation (POOL) were the leading contributors to the performance of the Select Value Strategy during the quarter. Our comments can be found above.
Select Value Top Detractors
Emergent BioSolutions (EBS) and Scott’s Miracle-Gro, Inc. (SMG) were the leading detractors to the performance of the Select Value strategy and commentary is noted above.
Select Value Portfolio Activity
Payment processing and information technology consulting firm Evertec, Inc. (EVTC) was added as a high conviction holding to the Select Value strategy during the quarter, using the proceeds from the sales of Emergent BioSolutions (EBS) and PaySign, Inc. (PAYS).
Our Focus on the Long Term
U.S. equity markets have packed between one and two years of expected returns into the first six months of 2021. Economic activity has rebounded, and company earnings have been strong, coming off of a low base following the downturn. Supportive monetary and fiscal policy have also contributed to these results, although the stimulus from fiscal policy will fade in the second half of the year. We are pleased to have these returns and know our clients are, as well, but we caution that fundamentals matter and that elevated markets generally go hand in hand with higher risk. QSV always favors quality businesses, those with strong balance sheets and steady and growing free cash flows supported by durable competitive advantages. We see this emphasis on sustainable businesses purchased at reasonable valuations as critically important in the coming quarters, helping our investors navigate the opportunities and challenges that will come.
Returns are for the respective composites of QSV Equity Investors (BEM). Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the BQV Midcap Strategy are compared to the historical performance of the Russell Midcap Indices as they are widely used benchmarks for mid capitalization securities. The returns of the BQV Smallcap Strategy are compared to the historical performance of the Russell 2000 Indices as they are widely used benchmarks for small capitalization securities. The returns of the QSV Select Value Strategy are compared to the historical performance of the Russell 2500 Indices as they are widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the BEM products and these indices. Furthermore, these indices do not include any transaction costs, management fees, and other expenses, as do the BEM Products. Lastly, BEM may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries a risk of loss.
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