It’s been quite a year for the FTSE 250 Index (MCX), with the basket of mid-cap companies now firmly established above 20,000 after a rise of more than 12% since January. Contrast this with the tepid performance of the FTSE 100 Index (UKX), up 6%, largely thanks to a pre-Christmas flourish in recent days.
However, it’s likely that life is about to get tougher for stocks in the FTSE 250 as this benchmark of UK performance comes up against Brexit-related headwinds. As UBS’s Mid-Cap Magnifier note points out today, fading support from sterling and commodities will make finding second-tier winners ever more challenging.
But, even though mid-caps now look more expensive relative to blue chips, UBS said it continues to see attractive opportunities. To demonstrate, it has just updated its UK mid-cap top picks based on ideas from across its research team.
Looking into 2018, the broker has rejigged its First XI line-up through the addition of Crest Nicholson (CRST), Kaz Minerals (KAZ), Paragon (PAG) and National Express (NEX).
The transport group wins a place because its operations in the United States, Spain and Morocco give the company a much more diversified portfolio than its UK-based peers. UBS believes that NatEx shares should trade at a premium to the sector, leading to a potential 10% upside in the price to 410p.
Housebuilder Crest Nicholson is another favourite among FTSE 250 stocks, with UBS highlighting its sustainable dividend yield of 7% as among reasons for inclusion in its mid-cap list. Banking group Paragon also makes it into the First XI, partly because its yield of 3.3% is covered more than twice by earnings.
Making way for the four new stocks are Bellway (BWY), Cairn Energy (CNE), Greggs (GRG) and Ladbrokes Coral (LCL). The bookmaker is ousted having surged on the back of its GVC Holdings merger, while Cairn is up more than 7% since October.
Howden Joinery (HWDN) has performed well since the autumn, but retains its place on the list with the potential for a further 7% upside to 475p.
Near-term demand for the kitchens supplier is uncertain, but UBS said the risks on volume weakness and rising costs are more than priced in with Howden.
They said: “We see continued medium term upside potential from new depot openings, depot maturity, and price rises. Cash generation is strong and could result in further cash return in oncoming years.”
The other members of the UBS list are Ashmore (ASHM), Elementis (ELM), Rotork (ROR), Serco (SRP), SThree (STHR) and Vesuvius (VSVS). Serco has been the weakest performer since October, down 20%, on weakening sentiment around UK outsourcing.
Rotork and Vesuvius are also included in UBS’s European small caps Top 20, with the former benefiting from expectations that management will be able to return the flow control business to 25% margins within five years.
Since inception in December 2016, the UBS mid-cap list is up 20%, compared with a rise of 13% for the FTSE 250. Technology, basic materials and insurance in particular have seen the strongest share price performances in the FTSE 250, with retail, telecoms, oil and gas and utilities seeing both the weakest earnings momentum and share price performance since the EU referendum vote.
With UBS expecting the UK economy to deteriorate in 2018, the bank has opted for companies with strong market positions and a track record of delivering in difficult conditions.
The uncertainties caused by Brexit mean that UBS thinks GDP will slow further in 2018 to 1.1%, before continuing at the same pace in 2019.
They said: “While UK headlines do not appear that attractive we continue to see selective opportunities in UK mid caps. We also see a relative picture that has some specific attractions versus both the FTSE 100 and Europe.”
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.