QSV Equity Investors
Q4 2021 Commentary
More information including a since-inception performance for each of the strategies may be found at www.qsvequityinvestors.com.
Equity markets marched higher in the quarter, with returns in large capitalization indexes outpacing those of small cap indexes. Businesses and investors faced numerous challenges – research firm Sentieo cited “supply chain,” “inflation” and “variant” as the most mentioned words on Wall Street calls – but returns were lifted by an ongoing combination of favorable monetary policy and fiscal stimulus which has fueled earnings growth into the second year of economic recovery. Investors have been slowly moving away from the higher beta and long duration stocks that led the market since the 2020 lows to lower beta, higher quality defensive stocks more recently. Using the Russell Stability indexes as proxies for high and low quality, the Russell Defensive indexes containing businesses with higher Returns on Assets, lower leverage, and lower volatility meaningfully outperformed lower-quality businesses, as measured by the Russell Dynamic indexes, across the market cap spectrum.
QSV Strategy Quarterly Performance
The QSV Quality Value Smallcap Strategy returned 6.67% and 6.57% gross and net of fees, beating both the Russell 2000 Value and Russell 2000 Indexes’ returns of 4.36% and 2.14%, respectively. Quality “QSV-like” businesses, those with less sensitivity to economic and credit cycles and with more sustainable business models, outperformed. Active returns were greatest in the Healthcare, Communication Services, and Financials sectors, while Utilities and Cash detracted from performance. Security selection was a strong contributor to performance, with the most impactful contributions in Healthcare and Real Estate companies.
Quality Value Smallcap Top Contributors
Forward Air (FWRD) rose over 45% during the quarter as the company continues to grow organically and through acquisitions. FWRD is the leader in the deferred airfreight transportation market, where it provides time-sensitive ground transportation (airport-to-airport) to other transportation providers such as freight forwarders and airlines. The mix of FWRD’s business is shifting to higher margin, less labor-intensive palletized cargo which bodes well for an improvement in its already strong 12% return on invested capital.
National Storage Affiliates Trust (NSA) shares rose during the quarter as occupancy rates and pricing power remained high. The company continues to grow through acquisition, focusing on secondary markets where there is less competition for properties and where the company believes there is less sensitivity to economic fluctuations. NSA raised its dividend for the third consecutive quarter in November while maintaining a conservative payout ratio.
Quality Value Smallcap Top Detractors
Although PaySign (PAYS) beat revenue estimates for the quarter and raised the bottom end of its guidance for full year EBITDA, shares fell significantly during the quarter. The business performance continued to be impaired because of the impact of the COVID pandemic on the company’s plasma business. PAYS also cited pandemic-related government stimulus programs as disincentives for individuals to donate plasma. QSV exited its position in PAYS in favor of better ideas.
As with many retail and e-commerce stocks, shares of 1-800 Flowers.com (FLWS) fell sharply during the quarter. Headwinds to the company’s results include supply chain issues, including rising shipping and container costs, and higher labor rates. FLWS is working to offset some of these challenges with price increases and greater automation. The company has also made accretive acquisitions, including a seller of premium seafood and organic foods, Vital Choice, which offers synergies with existing holding Harry & David. FLWS continues to have strong average returns on invested capital of 12% and continues to be a holding for QSV.
Quality Value Smallcap Portfolio Activity
QSV exited positions in Physicians Realty Trust (DOC), Dril-Quip Inc. (DRQ), InterDigital Inc. (IDCC), MGE Energy, Inc. (MGEE), PaySign Inc., (PAYS), and Zynex Inc., (ZYXI). Zix Corporation (ZIXI) was excited as it was acquired by OpenText, a provider of information management solutions. QSV entered new positions in Frontdoor Inc. (FTDR), a provider of tech-enabled home services and warranties, and Getty Realty Corp. (GTY), owner of a convenience store and gasoline station properties that operate under brands including BP, Citgo, Exxon, and Shell. Also added were Postal Realty Trust (PSTL), the only publicly traded REIT focused on the management of properties leased to the U.S. Postal Service, and Progress Software Corp. (PRGS), a provider of cloud-based security solutions.
The QSV Quality Value Midcap Strategy returned 10.65% and 10.38%, gross and net of fees, for the quarter, leading both the Russell Mid Cap Value Index return of 8.54% and the Russell Mid Cap Index return of 6.44%. QSV added value in the Consumer Discretionary and Healthcare sectors, while Energy and Utilities exposures detracted from strategy performance. Security selection delivered an excess performance in 7 of 11 S&P sectors, with selection in Healthcare and Consumer Discretionary companies delivering the most meaningful returns.
Quality Value Midcap Top Contributors
Extra Space Storage Inc. (EXR) was the second largest contributor to performance during the quarter. EXR controls the second largest self-storage portfolio in the United States. Its scale advantage and the data that is derived from its portfolio allows EXR to move swiftly when adjusting pricing to reflect changing market trends. High occupancy rates and acquisitions supported robust performance during the quarter.
Swimming pool supplies provider Pool Corp (POOL) was the greatest contributor to performance during the quarter. The stay-at-home environment buoyed sales of Pool’s products and its share price. While the expected sales in new residential pools have slowed from strong pandemic growth, these represent less than 20% of sales for the company and its installed base will continue to deliver strong results, in our view. POOL has average returns on invested capital of 27% and continues to be a holding for QSV.
Quality Value Midcap Top Detractors
Core Laboratories (CLB) was the leading detractor from performance as COVID-19 related disruptions, hurricanes in the Gulf Coast, and supply chain issues impacted its business performance. CLB is the leader in providing core and reservoir analysis to oil and gas companies. Competitive advantages include its intangible assets (patents, proprietary technology, and human capital) and network effects (multi-client reservoir studies). The company anticipates growing customer demand in both the U.S. and international markets in 2022 and has increased raw materials inventories to address its supply chain challenges. CLB is one of the more profitable names in the group and continues to be a holding.
Despite quarterly performance that met expectations and raising the company’s guidance for the full year, Fleetcor Technologies Inc. (FLT) detracted from performance during the quarter. FLT is a provider of global business payment processing solutions, processing more than 1.6 billion transactions each year in segments that include trucking, lodging, toll roads and corporate payments. Its scale in these segments and the growth in business-to-business payments serve as strong moats for the business. Supply chain bottlenecks and driver shortages have impacted trucking within its fuel payments segment, but we see these as short-term issues and have conviction in the business.
Quality Value Midcap Portfolio Activity
QSV exited Physicians Realty Trust (DOC), MGE Energy, Inc. (MGEE), MSCI Inc. (MSCI), and Waste Connections (WCN), during the quarter. Aspen Technology (AZPN) was exited as it entered into a definitive agreement to be acquired by Emerson Electric, a global technology and engineering company. New positions were initiated in consumer products company Church & Dwight (CHD), the well-known provider of cleaning and disinfecting products company Clorox (CLX), food and snack company Campbell Soup (CPB), and video game publisher Take-Two Interactive Software, Inc. (TTWO).
The QSV Select Value Strategy returned 9.44% and 9.20%, gross and net of fees, leading the returns of 6.36% and 3.82% for the Russell 2500 Value and Russell 2500 Indexes, respectively. Select Value is a high conviction strategy that takes WSV “best ideas” from its Quality Value Smallcap and Quality Value Midcap strategies. Exposures in the Healthcare and Consumer Discretionary sectors aided returns, while the Industrials and Energy sectors detracted. Security selection can be credited for all the outperformance for the quarter, with Healthcare, Consumer Staples and Information Technology holdings most notably contributing.
Select Value Top Contributors
National Storage Affiliates Trust (NSA) was the leading contributor to performance during the quarter. Its results are noted above.
Pool Corp (POOL) was the second greatest contributor to performance during the quarter. Its results are discussed above.
Select Value Top Detractors
Core Laboratories (CLB) was the leading detractor from performance in the Select Value strategy and is discussed above.
Fleetcor Technologies Inc. (FLT) was the second largest detractor from performance during the quarter and is also addressed above.
Select Value Portfolio Activity
Adhering to QSV’s emphasis on owning its best small and mid-cap ideas within the Select Value portfolio, new positions were initiated in Church & Dwight (CHD), Getty Realty Trust (GTY), and Take-Two Interactive Software (TTWO). QSV exited its holdings in Aspen Technology (AZPN), MSCI (MSCI), and Waste Connections (WCN).
Our Focus on the Long Term
For much of 2021, the markets rose seemingly without concern for potential risks. QSV sees the New Year through the lens of opportunity, but with a keen eye on risk management through ownership of quality businesses. Known risks include:
The potential impact of each of these is important for investors to consider, yet the macro future is not knowable. We do know that rising rates will impact the valuations of equities, particular higher growth names heavily reliant on future earnings. We also know that lower quality value stocks had their day in the sun in 2020 and early 2021 after briefly being left for dead at the start of the pandemic. QSV believes that our area of focus – quality businesses with durable competitive advantages, strong balance sheets and strong cash flow generation – will serve investors particularly well in the coming year and beyond. These businesses, purchased at reasonable valuations, have a long history of providing solid participation in rising markets and shock absorption for the surprises that 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 a 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 a 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 a 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 risk of loss.
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