Page 30 - DIY Investor Magazine | Issue 32

CONSUMER MID-CAPS SET TO BENEFIT FROM A RETURN TO NORMALITY
The past five years have been a mixed time for the UK mid- cap company universe as Brexit and then Covid-19 have led to bouts of market nervousness that have hit domestically- focused stocks particularly hard.
But since March 2020, and notwithstanding blips of market turbulence along the way, UK small and mid-caps have climbed fairly steadily. Although uncertainties remain, concern regarding the financial impact of the pandemic has receded and government support has enabled UK businesses to continue to keep the lights on.
Over the past year in particular, successful trials and roll-out of the Covid-19 vaccine, plus a recognition that both small and mid-caps had become substantially undervalued have helped many of these companies to power ahead. So what further mileage has the mid-cap universe got from this point on and what are the potential risks for investors in this space? Well, looking at risks first, investing in smaller and medium- sized companies can be riskier than investing in their larger counterparts while focusing on a particular country – the UK in this instance - adds a layer of country-specific risk.
Nevertheless, as markets strive to achieve post-Covid 19 normality and post-Brexit trade evolves, we would argue that there is potential upside, with strong performance of selective mid-sized UK companies likely to be driven by a number
of factors. First, the UK continues to see a robust economic rebound as consumers spend savings accumulated during lockdown. Indeed, economic recovery has been a lot stronger than expected while unemployment levels have remained lower than feared – even following the end of the government’s furlough scheme.
Indeed, in its economic and fiscal outlook published on 27 October 2021, the Office for Budget Responsibility forecast year-on-year GDP growth of 6.5% in 2021 and 6% in 2022, falling back to 2.1% in 2023. Recent concerns over fuel supplies and rising gas prices caused non-essential spending growth to slow a little (12.9% in September 2021 compared to 15.8% in August 2021 according to Barclays’ UK Consumer Spending Report for September 2021.
‘STRONG PERFORMANCE OF SELECTIVE MID-SIZED UK COMPANIES LIKELY TO BE DRIVEN BY A NUMBER OF FACTORS’
But with UK households having built up over £150 billion in excess savings, we believe discretionary spending still has much further to go.
Second, greater trading certainty in a post-Brexit world is helping to support earnings prospects. UK corporate earnings are expected to grow 27% in 2021 and 13% in 20221 – and we believe mid-caps that meet our criteria for quality can grow faster than this. Finally, attractive mid-cap valuations are encouraging merger and acquisition activity, which seems to inject further dynamism into the sector.
For all these reasons we are very positive on mid-caps and on consumer discretionary stocks in particular. Half – 50.7% as at 31 October 2021 – of our portfolio is currently allocated to consumer discretionary compared to 26.8% for the benchmark. A number of these companies have performed very well for us during lockdown and continue to do so.
UK media company Future, for example, is currently our biggest holding, accounting for 5.7% of the portfolio as at the end of October 2021. Future is skilled at two essential things: producing content cost-effectively then monetising it effectively.
This has allowed it to acquire media content businesses, reduce their costs and harness income streams from their assets very efficiently. The combination of M&A, strong organic growth, margin improvement and high cash conversion has allowed Future to deliver repeated earnings upgrades over the past three to four years.
‘WE ARE VERY POSITIVE ON MID-CAPS AND ON CONSUMER DISCRETIONARY STOCKS IN PARTICULAR’
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