Interactive Investor

City heavyweight names mid-caps to buy now

6th October 2015 11:03

Harriet Mann from interactive investor

In times of global uncertainty, investors have favoured the security of blue chips. Wrong, says broker Citi. Instead, investors have erred towards mid-cap companies, which has actually protected them against macro volatility. The analysts have compiled a list of those shares best-placed to negotiate near-term volatility.

In September, the FTSE Small-Cap index fell 2.4%, beating both the FTSE 250 and the Top 100, down 3%. So far this year, the mid-cap index is up 3.7%, small-cap's 2.7% and the FTSE 100 has slumped by 7.7%.

"Financial markets are displaying increased share price volatility in response to global macro uncertainty," explain Citi. "Surprisingly, realised volatility for the FTSE 100 is above the FTSE 250 and is at the widest premium since 2009. This dynamic could reflect the more domestically focused earnings of UK small caps relative to their bigger cap peers."

Headed by James Wheatcroft, Citi argues we are in phase three of a four-phase credit/equity cycle, during which large companies historically outperform their smaller counterparts. However, Wheatcroft admits there has been little evidence of this so far due to weak commodity prices and overseas exposure, which has arguably weighed on FTSE 100 performance.

After the blue-chip sell off, the FTSE 250 now trades at a premium to the FTSE 100, on 17.4 times 2015 earnings estimates and 15.3 times 2016 earnings. That's 21% above its historical average. The Footsie trades on 14.7 times 2015 earnings, dropping to 14 times. However, the FTSE 250 trades in line with the large cap index excluding financials, oils and mining, which have respective price/earnings multiples of 17.2 times and 15.9 times.

Expecting M&A activity to increasingly fuel balance sheet growth going forward, Wheatcroft says: "The key is finding stocks which can demonstrate earnings growth (in a backdrop of long-term net downgrades) and positive momentum regardless of the multiple macro/political influences."

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The analysts' pick of quality mid-caps include recruiter Michael Page, airport food and drink retailer SSP, surgical group Al Noor Hospitals and subprime lender Provident Financial (see chart). Their pick of the companies with the best earnings momentum include miner Petra Diamonds, Indivior - the pharma unit spun out of Reckitt Benckiser's - and Virgin Money.

Favouring those who make over 50% of revenue in the UK and with a strong balance sheet - net debt/cash profits of less than 2.5 times - Citi likes Ashmore, Halfords, MoneySupermarket, Saga, Booker, TalkTalk Telecom, Debenhams, William Hill, Britvic, Betfair, Just Eat, Cineworld, SIG and IG Group.

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High chance of China-led recession

Citi's chief global economist Willem Buiter still reckons there is a high chance a Chinese, Emerging Market and global recession will play out next year. He flags the following stocks as ones to keep a wary eye on - all have combined Asia Pacific and Latin America revenue exposure of over 20%: Cable & Wireless, Premier Oil, Rotork, Spirax-Sarco, Wood Group, Informa, Vesuvius, Aggreko, Hays, Man Group, Victrex and Petrofac.

With quantitative easing in Europe and low rates remaining in the UK, investors will continue looking for income. This lot have a 2015 dividend yield of over 3.5% covered at least 1.5 times by earnings, and are forecast to grow dividends by over 5% in 2015 and 2016 - bike retailer Halfords, soft drinks firm Britvic and pub chain Greene King. For sustainable dividends, look at Halfords again, Indivior, media giant UBM and bookie William Hill.

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Within its small and mid-cap (SMID) coverage, the analysts have compiled a key buy list which has outperformed the FTSE 250 index (up 87%) by 160% on an absolute basis since inception.

After adding online payment group OPAY and cinema firm Cineworld to their coverage, online betting group Betfair and Indivior have been upgraded to 'buy'.

Takeaway portal Just Eat and SSP Group stormed ahead with growth of 4.1% and 3.5% respectively. But after the recent departure of CEO Tim Howkins from IG Group, Citi is cashing in its profits and removing spreadbetter IG group from the list. After a 14% fall during the month, heat treatment specialist Bodycote is out, too. Budget retailer Poundland also crashed by 18.8%, engineer Senior by 12.1% and roofer SIG by 7.6% - although they are safe on the buy list, for now.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. 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.