Can we begin with a company in which you have high confidence but that has not yet participated in the market’s rebound?

I think TGS-NOPEC Geophysical fits that description very well. The company is headquartered in Norway and is the world’s largest provider of seismic data to oil and gas developers on a multiclient basis. Its stock fell 51% in the first half of 2020, performing slightly better than the energy equipment & services industry within the Russell 2000, which declined 53.4% for the same period. Investors tend to see TGS as a capital-intensive, high fixed cost, commodity oilfield services company when in reality its business model is that of a data services provider. It’s an asset light business that doesn’t own the boats which are used to collect seismic data. In addition, we like its high contribution margin—TGS repackages the same data and sells it to multiple clients—and high variable costs, such as vessel rental rates, which are in decline. TGS has also been cutting costs, including reducing executive compensation, to better deal with the recent challenges to its industry.

TGS-NOPEC Geophysical (Nasdaq: TGS-NO) 2020

The company is built to weather downturns as it has been consistently free cash flow positive, including during each year of the energy “depression” from 2014-2016. Although spending on seismic is among the first expenses cut by exploration & production (“E&P”) companies during industry downturns, reserves remain the lifeblood of these companies. Their importance makes TGS’s seismic studies vital to reducing costs and allowing E&P companies to maintain value and meet demand when supply rebalances.

What about a Premier holding that’s done well so far in 2020?

Bio-Techne is a good example—it was one of the portfolio’s top contributors in the first half of 2020. Bio-Techne is a leading developer and manufacturer of high-quality purified proteins, reagent solutions, and tools used in clinical and diagnostic research. Its near-term growth is being suppressed by temporary, COVID-19-driven research lab closures, especially in academia. However, the company has seen a partial offset in the form of accelerating demand for its consumables and diagnostic tools as biopharma companies race to develop tests for both the coronavirus and antibodies, as well as for patient monitoring. In addition, the company entered into a partnership with Mt. Sinai and Kantero Biosciences and is awaiting emergency approval for its own quantitative serological antibody test for the virus that it believes will have unmatched accuracy.

Bio-Techne (Nasdaq: TECH) 2020

Beyond COVID-19, Bio-Techne has what we think are tremendous long-term growth opportunities within both its existing product portfolio and in development. The company’s reagents and analytical solutions are critical “picks and shovels” in more general life sciences research and development. Since the arrival of its current CEO in 2013, the company has tripled revenues via aggressive new product development, geographic expansion, and acquisitions.

Even on this larger revenue base, we think double-digit organic growth can be sustained over the next several years as Bio-Techne leverages its consumables portfolio into new growth areas, such as manufacturing proteins for commercial use in the rapidly expanding cell and gene therapy areas, and as market adoption of its tissue and liquid biopsy offerings takes hold. Finally, with modest financial leverage, the company is also poised to resume layering on additional growth vectors via acquisition.

Can you tell us about a newer portfolio holding?

Yes. Forrester Research is an independent technology research firm. Companies use its proprietary reports, events, real-time survey data, and consulting services to analyze key technology trends impacting businesses and determine the strategies and IT investments needed to stay competitive or harness those technologies to their advantage. We’ve known the company and its management for many years. We had a small position in Premier back in 2000, and Forrester is also a direct peer of Gartner (IT), a former holding in Premier’s portfolio.

Forrester Research (Nasdaq: FORR) 2020

Forrester is a high-return, strong free cash flow business model characterized by recurring revenues, with approximately two-thirds of sales in annual research subscriptions and a 90% renewal rate. It boasts high-margin sales by reselling the same information to different buyers with little incremental expense—an information services/publishing model. We also like that it’s a people-intensive—as opposed to capital intensive—business model. Forrester carries no inventory and collects subscription fees in advance of delivering its research. The company has been free cash flow positive every year since its IPO in 1996, and its free cash flow conversion averages about twice its net income. Reflecting these favorable business attributes, Forrester’s five-year average ROIC was 32.8% at the end of June. Finally, we see a number of key secular growth drivers, including the ongoing digital transformation of businesses as companies continue to invest in IT to expand e-commerce and work-from home capabilities, run their businesses more effectively and flexibly, and to differentiate through improved customer experiences.

In light of all the current economic uncertainty, what is your outlook for small-cap stocks?

The sustainability of the “reopening rally” for stocks is certainly in question now that coronavirus cases have resurged. At the start of the third quarter, the primary hotspots are now in five states that collectively account for 37% of U.S. GDP: California, Texas, Florida, South Carolina, and Arizona. Many affected states slowed or reversed reopenings, which could stall the economic recovery. Another brick in the wall of worry is the fate of consumer demand as several of the temporary financial assistance programs Congress enacted are set to expire, as some did at the end of July. Various $1 trillion-plus stimulus packages and other measures are under discussion, but failure to act could cause consumers to curtail discretionary and durable goods expenditures, and companies may turn employee furloughs into permanent workforce reductions. Finally, the November elections are looming. The market appears to have begun pricing the probability of a victory for former Vice President Biden, while political observers believe odds are also increasing that the Democrats could gain a majority in the Senate and thus full control of Congress. I think uncertainty down the home stretch and emerging details about each party’s respective policy platforms will create additional volatility amid speculation about perceived sector winners and losers.

In spite of the 46.0% rise from the recent low on 3/18/20 through the end of June, the Russell 2000 was 14.9% below its prior peak from August 2018. In the 23 small-cap bear markets since World War II (excluding this year’s), after small-caps recovered their losses and returned to the prior peak, they then went on to generate another 64% return on average to the next cycle peak. If history holds, there appears to be ample room for U.S. small-caps to run.

So I’m excited about the prospects for our Premier Quality Strategy given the qualities and reasonable valuations of the companies we own, as well as the favorable performance backdrop for U.S. small-caps following low-return periods. I also see a potential benefit from a rotation to more economically sensitive cyclical stocks as the U.S. economy emerges from recession. As growth expands to other sectors and industries, investors will have more investment options, which should result in more attention on quality and valuation.

Royce Premier Fund

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