Manager Insight

"Micro corrections" present opportunities, says Felix Narhi.
By Michael Ryval | 01/03/18

With roots in the venture-capital arena, PenderFund Capital Management Ltd. gravitated easily to the small-cap space, mainly because of the abundant opportunities to find attractive, little-followed smaller companies. That focus has broadened in the past few years to the all-cap universe, which presents unloved stocks that the firm says are ripe for the picking.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"We began in 2003 as a venture-capital private-equity firm investing in smaller companies in British Columbia," says Felix Narhi, chief investment officer of the Vancouver-based firm, which manages about $720 million. "This knowledge base was transferred into the smaller-company space. Once Pender became a prospectus-based fund company in 2009, it was a natural progression. There are more opportunities because fewer people are following small companies, which tend to be more misunderstood."

A 14-year industry veteran who joined PenderFund in 2013, Narhi's roles include portfolio manager of the $20-million Pender US All Cap Equity and co-manager of the flagship $283-million Pender Value. Narhi stresses that, personally, he is size-agnostic and focuses on all-cap stocks, "albeit I recognize that there tends to be better opportunities in smaller-sized companies."

Still, he notes that the flagship Pender Value is a "best ideas" portfolio which draws on input from the entire PenderFund investment team and contains some of his high-conviction ideas sourced from the U.S. all-cap investment universe. (In contrast, PenderFund CEO Dave Barr, who is lead manager of Pender Small Cap Opportunities, gets his best ideas from the Canadian micro-small-cap universe.)

Narhi, who holds a bachelor of commerce degree from the University of British Columbia, seeks to identify individual companies that have had what he describes as "micro corrections," by which he means price drops that are specific to that stock rather than driven by a general market downturn.

It's the unloved names that particularly attract Narhi. Take, for instance,  Wynn Resorts Ltd. (WYNN), which operates hotels and casinos. The stock peaked in 2014 at about US$246 in 2014, but crashed to about US$55 in late 2015 when a Chinese crackdown on corruption impacted its revenues in Macao. At that point, the stock was a mid-cap name. "The stock was clearly unloved and we bought it in the low US$60s."

Late this January, as the stock appeared to be richly priced, and peaking above US$200 per share, and coinciding with sexual harassment allegations levelled at CEO Steve Wynn, Narhi sold off the remaining position. "The facts had changed around the story. So we took our money off the table."

As a value-oriented stock picker, Narhi favours companies that are selling below their intrinsic value. Moreover, he has a bias to companies run by their founders. In particular, he seeks so-called predictive attributes which the market undervalues. "We tend to hold a lot of owner-operators," says Narhi. Referencing a study by management-consultancy Bain & Co. concluding that between 1990 and 2014 founder-owned companies produced three times more wealth than manager-run companies, Narhi adds: "To us, that's material."

One high-conviction example in Pender Value, is  Baidu Inc. (BIDU), held as an American Depository Receipt, which has a market cap of US$88 billion. Although it's a large-cap stock, Narhi points out that it is relatively small compared to mega-giants such as  Facebook Inc. (FB). The Chinese multinational, which specializes in Internet-based services, is run by founder Robin Li and is regarded as the Google of China. "It had a hiccup in the core business of search advertising," says Narhi, adding that the stock fell on accusations by a fatally ill user that the company was guilty of misleading advertising.

Bought in the spring of 2017 for about US$170, the stock is up close to 50%. But Narhi believes there is more upside, based on Baidu's investment in areas such artificial intelligence (AI). "It is the leader in China and the Chinese government is backing it," says Narhi, adding that the stock is also undervalued because it has stakes in IQIYI, the largest online video service in China, as well as other interests. "It also has stakes in some private technology companies in China. They might be worth a lot in 10 years. Right now we're getting them for free."

Another favourite name held in Pender Value and Pender US All Cap Equity is  Platform Specialty Products Corp. (PAH), a U.S.-based mid-cap producer of specialty chemicals that is focused on the industrial and agricultural markets. Because of its significant reliance on emerging markets, its stock has been hit. "They bought a lot of companies using debt and then the markets turned. Investors soured on companies with high financial leverage. So there have been a lot of headwinds. We accept there are good cycles and bad cycles. If the tide is too tough, it doesn't matter how good a swimmer you are."

Yet Narhi believes the tide has turned because emerging markets are recovering and the currency effect, which hit Platform Specialty Products when earnings were translated into U.S. dollars, has diminished. Moreover, this coming summer the company is expected to split into two parts, a plan that most investors have applauded. With the stock trading at about US$10.60, Narhi believes it could double within two to three years.

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