- Positive set-up for UK mid caps
- Valuations attractive versus history
- Bellway, Babcock, Premier Foods among names to watch
By definition, mid caps have the potential to become the UK’s next large cap leaders. But in recent years, many of the UK’s most promising ‘second liners’ have been acquired, either by private equity buyers or overseas companies looking to take advantage of the UK’s cheap valuations.
Given that so many FTSE 250 names have disappeared from the market, are there any quality mid caps left worth investing in?
OPPORTUNITY KNOCKS
Guy Anderson, portfolio manager of The Mercantile Investment Trust (MRC), certainly thinks so.
He highlights a noticeable pick-up in the number of acquisitions by corporate buyers last year, particularly targeting medium and smaller-sized companies.
‘While this has reduced the number of businesses listed on the stock exchange, takeovers have typically involved firms facing operational challenges,’ explains Anderson.
‘In contrast, we remain focused on strong, well-performing companies and there are still many attractive UK-listed opportunities to choose from. Right now, we’re finding more companies we want to invest in than sell. Our current gearing level of over 13% reflects the strength of these opportunities and the confidence we have in the market.’
Tim Service, manager of the Jupiter UK Mid Cap Fund (B1XG948), says: ‘Our investment process tilts us to higher quality businesses, and we have notably under-indexed in terms of being on the receiving end of bids. Generally, takeovers are targeted at troubled businesses, where private equity thinks it can do a deep repair job away from the glare of the market, or subscale businesses, where a corporate acquirer thinks it can extract sales or cost synergies.’
Service add: ‘We would like to think our portfolios are well represented in quality UK businesses, which we hope have bright futures ahead of them. That said, it is not healthy for UK equity markets to have a diminishing pool of companies available for investment.’
OPTIMISTIC OUTLOOK
Despite global market volatility, Anderson remains optimistic on the outlook for UK mid caps.
‘Given their greater economic cyclicality and sensitivity to interest rates, medium and smaller size companies are trading at a notable discount relative to their historical levels versus larger companies, offering an attractive entry point for long-term investors,’ says Anderson.
‘However, if interest rates continue to trend lower, this should create a more supportive environment for growth. In these circumstances we’d expect medium and smaller sized companies to outperform, given their stronger exposure to domestic economic activity than the broader UK market.’
Jupiter’s Service says the setup for mid caps is ‘generally attractive. Valuations are attractive versus international peers and history, and there is an argument that aggregate mid-cap profitability is below the long term trend. Given the subdued domestic economy, any improvement in the macro outlook and earnings growth could be above trend for a few years.’
STOCKS TO WATCH
Although the UK housing market has experienced its ups and downs, Anderson notes demand for quality new build housing across the country remains fundamentally strong, fuelled by the ongoing supply shortage.
‘Bellway (BWY), a FTSE 250 company with a 70-year trajectory from family business to one of the UK’s biggest house builders, is well placed to capitalise on this, as well as reforms to the planning system which are expected to boost production,’ he insists.
‘Other names we are excited about include trading platform operator Plus500 (PLUS), which recently delivered healthy gains as it successfully grew its customer base further while continuing to generate strong profitability and return cash to shareholders, and alternative asset manager Pollen Street (POLN), which focuses on private equity and credit and has set out ambitious growth targets following its combination with Honeycomb Investment Trust.’
Service says Jupiter Mid Cap’s biggest holdings - such as Babcock (BAB), Informa (INF), Telecom Plus (TEP), Bellway and Premier Foods (PFD) - are ‘all delivering attractive profit growth and reinvesting profits at good returns. They are mostly beating market expectations and mostly offering all of this at historically low valuations. Ultimately, this is what allows individual companies in the fund to deliver attractive returns for investors in the fund over time.’
DISCLAIMER: James Crux has personal investments in The Mercantile Investment Trust and Premier Foods.
