8 best mid-cap stock ideas

by Graeme Evans from interactive investor |

The UK budget could boost spending and highlight attractive valuations for UK mid-cap shares.

The superior returns of the UK's mid-cap market were in focus today when a City bank named Britvic (LSE:BVIC), McCarthy & Stone (LSE:MCS) and TalkTalk (LSE:TALK) among eight stocks to help continue that run.

Deutsche Bank also included Countryside Properties (LSE:CSP), Gamesys (LSE:GYS), GoCo (LSE:GOCO), Synthomer (LSE:SYNT) and Wizz Air (LSE:WIZZ) in a “balanced portfolio” for the first edition of its Top 8 Mid-Cap picks.

The aim is to help investors tap into the strong record of the UK mid-cap market, which has outperformed the FTSE 100 index in 15 of the past 20 years. Growth over those two decades has annualised at 6.3%, compared with 0.8% for the top-flight.

That includes 2019, when despite the overhang from Brexit the UK mid-cap market posted its strongest absolute performance in six years. Momentum has slowed at the start of 2020, but Deutsche sees the potential for the UK budget to boost spending and highlight the attractive valuations within the UK-facing mid-cap market.

It currently trades on a 15x price/earnings (PE) multiple for 2020, with its significantly higher growth track record justifying a premium to the FTSE 100 index at 13.5x.

The bank said:

“We are encouraged by signs of life in the residential property market and see a number of company-specific catalysts which can drive outperformance.”

This view is reflected in the inclusion of Countryside Properties, which has a South East-based housebuilding business as well as North West-focused Partnerships division specialising in urban regeneration of public sector land.

Source: TradingView Past performance is not a guide to future performance

Deutsche said a number of factors made the latter an appealing area, leading to a much higher return on capital employed than enjoyed by almost all other housebuilders. The shares have rallied strongly from 277p last summer to trade at 503p, although with a PE of 10x analyst Jon Bell thinks there's potential for further gains.

He also picks McCarthy & Stone, given that shares are currently on an undemanding PE of 12x and yield about 4%. The company has 70% of the UK retirement homes niche but has suffered in recent years from a lack of liquidity in the second-hand housing market.

Bell added: “We observe a material improvement in confidence since the General Election and believe this should stimulate activity levels. There is also the possibility that the government could take the opportunity to further reform the Stamp Duty regime in the forthcoming Budget.

“Either way, McCarthy has been repositioned for recent market conditions – anything better than this would be upside.”

Another unloved stock included in the Top 8 is TalkTalk, which has a target price of 190p compared with 108.7p currently. Deutsche analyst Robert Grindle thinks that the company's decision to focus solely on fixed broadband should see increasing benefits.

He points to the recent proliferation of operators building full fibre networks to compete with BT Openreach, which should help to reduce wholesale costs and enable TalkTalk to achieve higher gross margins and lower operating costs. Longer-term, Grindle said TalkTalk's four million customers may make it an attractive target for a fibre infrastructure owner.

Source: TradingView Past performance is not a guide to future performance

The potential for a re-rating at Gamesys is also highlighted by Deutsche analyst Simon Davies, who has a price target of 1,100p compared with 721p currently. He notes that the company, which is the market leader in online bingo in the UK and Spain, is the cheapest stock in the online gaming sector with a PE of 5.6x.

Gamesys boasts a capital-light model and is highly cash generative, which is why Davies thinks potential buy-backs from the second half of 2020 are an “obvious catalyst” for a material re-rating.

The other structural growth play in the portfolio is Wizz Air, which is Deutsche's top pick from the European airlines and transportation sector. Not only is it supported by fast-growing economies in central and eastern Europe, it is on track to deliver the highest operating margin of all the European airlines in the bank's coverage.

Analyst Jamie Rowbotham said Wizz traded in line with peers easyJet (LSE:EZJ) and Ryanair (LSE:RYA) on a PE of 14x for 2021, whereas a premium is warranted. His price target is 4,550p, compared with 4,206p currently.

Deutsche also sees the recent underperformance of Britvic shares as an attractive buying opportunity, particularly as cash generation is accelerating and the drinks company continues to deliver attractive EPS growth. Shares have a 1,100p target, against the current 899p.

The bank also sees price comparison business GoCo (LSE:GOCO) as a cheap stock, based on the potential for a re-rating of its Autosave switching service. It added that the valuation of Synthomer (LSE:SYNT), which is one of the world’s biggest suppliers of aqueous polymers, was compelling at 11.8 PE.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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