Now the ballots have been cast at the general election, the UK could become the ‘reassuringly boring’ market, both politically and fiscally, when compared to the more extreme politics on the other side of the English Channel and Atlantic Ocean.

So suggests Jean Roche, manager of the Schroder UK Mid Cap Fund (SCP), who notes capital allocators know more or less what to expect, which could explain the flurry of takeover bids seen in the FTSE 100, but also among FTSE 250 constituents such as beverages business Britvic (BVIC) and building products supplier Tyman (TYMN) to name a few.

SUPERIOR GROWTH PROSPECTS

The FTSE 100 may hog the headlines, but the FTSE 250, which comprises the next 250 largest companies outside of the blue-chip benchmark, has beaten most developed market indices over the long term, and that includes the tech-heavy S&P 500 across the pond.

Surprisingly, the FTSE 250 has also produced a higher proportion of ‘30 baggers’ than the US stock market over the past 30 years. While perceived as more of a play on the domestic economy, the FTSE 250 is the domain of a diverse set of often disruptive and growing businesses and roughly half the revenue its firms generate comes from outside the UK.

Within a UK market that remains inexpensive, as demonstrated by a growing number of takeover bids and share buybacks, mid caps have lost the premium valuation they historically enjoyed.

Yet mid caps are anything but a low-growth proposition, insists Roche. ‘The FTSE 250 is forecast to grow earnings per share in the low- to mid-teens this year, followed by a high-teens rate next year. What’s notable is that earnings growth has also been achieved by many high-quality UK mid caps this year, despite the rise in corporation tax from 19% to 25% which took effect in April 2023. This technical detail, which may have held domestic UK shares’ earnings back this year therefore, falls away from April 2024.’

With wage growth outstripping inflation and interest rate cuts on the way, a brighter UK consumer outlook offers another positive catalyst for the ‘second liners’ index. ‘It is just one measure, but we would point to the ASDA income tracker that has now shown double-digit growth for two months in a row as real earnings growth begins to feed through,’ adds Roche.

‘The level of disposable income is now the highest it has been since September 2021 This should be a welcome relief for many households and could benefit various UK mid cap retail and household goods stocks such as Dunelm (DNLM) and Pets at Home (PETS), which are 100% UK and, perhaps to a lesser extent, because they are more international, Games Workshop (GAW) and ME Group (MEGP).'

WHY MID CAPS ARE A MUST

Mid-cap companies are attractive to investors for a variety of reasons; more established than smaller firms, they are regarded as less risky, yet they also tend to be faster-growing than their larger, more mature counterparts and are a sweet spot for innovation and disruption.

Unlike many smaller companies, they have proven business models and unlike many large companies they may have a steep growth trajectory ahead of them.

Hugely diverse, the UK mid-cap sector is home to many fast-growing firms riding the wave of long-term structural growth trends, from the adoption of 5G and growing need for cybersecurity to the humanisation of pets and monetisation of strong intellectual property.

Schroder UK Mid Cap Fund’s managers Roche and Andy Brough refer to the FTSE 250 as the ‘Heineken Index’ given its potential to ‘refresh’ portfolios in a way other parts of the market cannot.

The mid-cap universe is constantly being disrupted by new challengers via market events such as IPOs, mergers and acquisitions, promotions from the small cap ranks and demotions from the large cap index.

Alexandra Jackson manages the Rathbone UK Opportunities Fund (B7FQM50), which seeks the best of British quality growth companies and had 44.84% of its portfolio invested in the FTSE 250 as of 31 May.

Jackson tells Shares there is still ‘a lot to go for in the UK market given valuations, positioning, ownership, M&A activity. We’ve barely even started down the road of all these catalysts.’

She highlights that ‘on a long-term basis, FTSE 250 names really do outperform their larger-cap peers, and quite surprisingly, they actually outperform their small-cap peers. Although 2022 and bits of 2023 saw an unusual reversion of the “mid-caps tend to outperform” truism, mid-caps provide the alpha in the UK.’

Why is it that mid caps outperform? ‘What you see is better earnings growth in the FTSE 250. It’s not just the top line – anyone can drive sales by buying other companies or pricing products very low – it’s about earnings growth and earnings growth in the FTSE 250 is superior to the FTSE 100, which is partly due to the sector make-up.’

The FTSE 100 is famously flush with stocks operating in old-economy industries such as oil and gas, mining, utilities and tobacco. ‘But it is also that mid caps tend to have lower leverage and higher margins and therefore higher ROIC (return on invested capital), which is the best predictor of share price return. When we look at FTSE 250 names, they kind of stack up more similarly to those really high-performing US shares,’ enthuses Jackson.

Also chiming in is Guy Anderson, manager of mid- and small-cap UK growth investor Mercantile Investment Trust (MRC), who points out that ‘over the past 30 years, the FTSE 250 (excluding investment trusts) has delivered a total return of 10% per annum, a significant margin above the FTSE 100, which has delivered just over 6%’.

‘Our view is that the long-term factors driving the outperformance of mid-cap companies, such as the potential for superior growth, remain intact, and from where we stand today, the outlook is looking increasingly promising.’

Anderson continues: ‘From a top-down perspective, and perhaps counter to the prevailing narrative, consumer and business confidence indicators are pointing to an improving picture. This could lay the foundations for greater consumer demand, more business investment, and thus lead to a better environment for corporate earnings growth.’

HOW CAN I GAIN FTSE 250 EXPOSURE?

Investors can gain actively-managed exposure to the theme through dedicated trusts including Schroder UK Mid Cap Fund, trading at a 10.9% discount to NAV (net asset value) with a 3.3% dividend yield at the time of writing.

Roche aims to pick companies with the potential of being tomorrow’s UK market leaders before the wider market has priced this potential into the shares.

Top 10 positions include international autos distributor Inchcape (INCH), IT reseller Computacenter (CCC), pork, poultry and pet food supplier Cranswick (CWK) as well as curtains-to-cushions seller Dunelm (DNLM).

Also offering plays on the mid-cap space are J.P. Morgan Asset Management stablemates JPMorgan UK Small Cap Growth & Income (JUGI) and the aforementioned Mercantile.

Managers Georgina Brittain and Katen Patel are bottom-up stock pickers with an excellent performance track record who look to capitalise on the lack of research at the smaller end of the UK market to find highly innovative or disruptive firms.

Mercantile, managed by Guy Anderson and Anthony Lynch, is a capital growth-focused, diversified portfolio of UK mid- and small-caps that pays quarterly dividends and aims to grow its shareholder reward at least in line with inflation.

The trust, which Anderson says remains focused on selecting ‘structurally strong individual companies likely to operate effectively in a range of market environments’, trades at a wide 11.7% NAV discount with a 3.3% yield which should appeal to bargain seekers.

Anderson is bullish about the outlook for software and hardware reseller Softcat (SCT). ‘As a supplier of technology products and infrastructure, customer service is key to standing out from the competition. The company’s focus on maintaining its unique culture, including driving employee engagement and running a highly successful graduate recruitment programme, has helped it deliver strong and sustained growth,’ explains Anderson.

‘Softcat is well placed to continue on this trajectory in an environment of improving business confidence, in addition to the increasing focus placed on technology to drive corporate productivity.’

Another actively-managed option is multi-cap stock picking fund Rathbone UK Opportunities, whose manager Alexandra Jackson gravitates towards mid-caps with durable business models and capable management who can take advantage of growth opportunities in their industry.

Holdings include Softcat, infrastructure products and galvanizing services supplier Hill & Smith (HILS) and electronic components designer DiscoverIE (DSCV).

There are several ETFs (exchange-traded funds) which track the FTSE 250 index. These ETFs offer a cost-effective way to invest in the second liners without the hassle of having to manage individual investments.

Among the ETFs available is the income-paying Vanguard FTSE 250 ETF (VMID), which has an ongoing charge of only 0.1% a year, and its accumulation class ‘VMIG’, which ploughs dividends back into the fund.

Alternatives include the £30 million Xtrackers FTSE 250 ETF (XMCX), with a total expense ratio of 0.15%, and the £122 million Amundi Prime UK Mid and Small Cap ETF (PRUK) with an ongoing charge of just 0.05%. Though this offers exposure to a different index than the FTSE 250, albeit with meaningful crossover. [JC]


MID CAP STARS - SHARES PICKS


Greggs (GRG) £27.62

Market cap: £2.8 billion

Food-on-the-go purveyor Greggs (GRG) almost needs no introduction, being so embedded in popular culture and across the UK retail landscape.

Although the pandemic pushed the Newcastle-based firm into losses for a couple of quarters, it managed to rebuild earnings and in late 2021 it set out an ambitious plan to double sales to £2.4 billion by 2026.

Key to the plan was an acceleration in store openings to around 150 per year along with extended evening opening hours, building on the initial success of its online and delivery channel and broadening the take-up of its app.

Half-way though the plan, the firm is on track to register close to £2 billion in sales this year thanks to more new stores, some in conjunction with supermarket chains Sainsburys (SBRY) and Tesco (TSCO), strong organic growth and new lines.

Hot products such as pizza and southern fried chicken have sold well in stores which stay open later, and alongside healthier choices and new over-ice drinks are being rolled out to more stores, while delivery sales and the app are all supporting volume growth.

With disposable income on the rise, Liberum analyst Wayne Brown argues low-ticket discretionary spending stocks like Greggs are likely to lead any recovery in the UK retail sector.

Shareholders already have been well rewarded this year with a 6% gain in the share price and a special dividend of 40p per share, equivalent to another 1.4%, on top of the increased ordinary dividend of 62p.

Despite this, the shares are cheap relative to their history on a cyclically-adjusted earnings basis, and when the firm reports first-half results at the end of July we expect chief executive Roisin Currie to stick to her plan to double sales which should give the stock a further lift. [IC]


Telecom Plus (TEP) £17.66

Market cap: £1.4 billion

The multi-utility supplier has a lot going for it right now: it recently passed the one million customer milestone in the three months to the end of March, the energy market is more ‘normalised’ and it continues to be an ‘asset light business'.

The group, which offers insurance, broadband and energy services under the Utility Warehouse brand, says over the medium term it is confident of doubling the business to two million customers.

The company’s shares have added 12% year-to-date compared with a gain of 4% for the FTSE 250 thanks to the resilience of its business against a tough macroeconomic backdrop.

In the firm’s favour, the energy market has become less volatile and energy prices have come down over the past year, while co-chief executive Stuart Burnett is positive about the company’s ‘unique multi-service model’ which he says has helped to provide market-leading savings for families across the UK while inflation remains high.

Unlike other suppliers, the company employs a word-of-mouth model for acquiring customers which it refers to as UWP (utility warehouse partners).

The company says almost 60,000 self-employed ‘distributors’ earn an income by referring Utility Warehouse to friends, family, and people they know.

Partner numbers increased by 14.1% to 68,251 for the year ending 31 March 2024 compared to 59,824 in 2023, and the firm is confident customer numbers will continue to grow, forecasting organic net growth of between 12% and 14% in the year to March 2025.

Adjusted pre-tax profit for the year to March 2025 is seen between £124 million and £128 million, with excess capital expected to be returned to shareholders through a combination of dividends and share buybacks. [SG]


Trustpilot (TRST) 214p

Market cap: £913m

It has been a fabulous year for Trustpilot (TRST), and as correctly predicted by Shares, the share price bounce has been high and sustained.

Since featuring as one of our Great Ideas investment picks (18 Jan) , the stock has jumped 33%, capturing most of 2024’s year-to-date 55% rally. Yet we remain convinced that this is a long-run growth story and that there remains substantial upside on the table for new investors. 

Like many digital commerce businesses, Trustpilot grew rapidly during the pandemic and its review platform now hosts more than 213 million consumer reviews of businesses and products across more than 893,000 websites. The company estimates posts are growing by more than one review per second and the platform generates almost nine billion monthly online impressions.

Increasingly, consumers don’t buy without the confidence of positive back-up from those who previously have. Crucially, network benefits hold huge promise in the years to come, creating a virtuous circle where consumers feel drawn to Trustpilot ratings because it is where meaningful services are listed and reviewed, and the more consumers who use Trustpilot, the more businesses will feel they cannot afford not to be on the platform.

It’s a very similar dynamic that has powered the likes of Rightmove (RMV) and Auto Trader (AUTO) to put up market-beating returns for years.

Sure, the stock continues to look pricey. Stockopedia has the 12-month rolling PE (price to earnings) multiple at 105, but as high-growth companies often prove, time and rapid earnings expansion will quickly whittle away the premium. 

Bear in mind, the stock is still nearly 20% below its 265p IPO (initial public offering) price, a level that at the time generated huge excitement in the markets. When analysts at Berenberg and Peel Hunt began covering the Danish company in summer 2021, both saw the stock hitting 430p.

While it has taken a little longer than originally hoped for Trustpilot to make a profit breakthrough, it now has, and rapid progress is on the cards. [SF]

 


Issue: 29 May 2014 - Page 16 |
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