Midcaps Manage Upward Mobility

4/7/2014


March Madness concluded in the days after this issue went to press. In this annual rite, college basketball teams from mid-major conferences regularly upend larger, more famous foes and lay waste to brackets filled out by even the most astute fans. 

Midcap stocks represent a similarly disruptive force in the stock market, with some of them destined to unseat established favorites. They are often more nimble than big companies and better-capitalized than smaller companies, making it easier for them to seize new business opportunities.

MIDCAPS GRADUATE
Just 35% of stocks in the S&P MidCap 400 Index on March 31, 2004, remain in the index today. More than twice as many stocks matriculated into the S&P 500 Index as retreated into the S&P Small Cap 600 Index. Interestingly, 43% of the midcap stocks from 10 years ago are now absent from the three indexes. Mergers likely account for most of the turnover.
S&P 400 Components From
Current Index Membership
5 Years
Ago
(%)
10 Years
Ago
(%)
S&P 500 Index (large-cap)
8
15
S&P MidCap 400 Index
62
35
S&P SmallCap 600 Index
7
7
Other
23
43

The median stock in the S&P MidCap 400 Index has a market capitalization of $3.80 billion, and 90% of stocks in the index have market caps of $1.56 billion to $8.08 billion. The midcap index has outperformed the S&P large-cap index over the last five and 10 years while topping the small-cap index slightly over the last 10 years.

Midcaps boast solid fundamentals, as outlined in the table below. The median S&P MidCap 400 stock generated stronger 12-month growth for earnings per share (11%) and sales (6%) than the median S&P small stock (6% and 5%). Despite the stronger growth, midcaps trade at a median 21.5 times trailing earnings, a slight (4%) discount to small stocks. Stocks in both indexes have averaged a median trailing P/E ratio of 18 over the past decade.

MIDCAPS: BETTER GROWTH AND VALUE THAN LITTLE BROTHERS
The median stock in the S&P MidCap 400 currently boasts a superior growth profile to the median stock in the S&P SmallCap 600. It also has a lower trailing and forward price/earnings ratio. All numbers are medians.
EPS Growth,
------ Last 12 Months ------
Sales Growth,
------ Last 12 Months ------
----- Trailing P/E Ratio -----
P/E On Current-
--------- Year Estimate ---------
Index
S&P
400
(%)
S&P
500
(%)
S&P
600
(%)
S&P
400
(%)
S&P
500
(%)
S&P
600
(%)
S&P
400
S&P
500
S&P
600
S&P
400
S&P
500
S&P
600
Current
11
9
6
6
4
5
21.5
19.5
22.3
18.9
17.3
19.4
10-year average
9
10
9
8
7
8
17.9
18.0
17.9
16.7
15.7
17.5
Recent as % of
long-run avg.
111
89
55
73
49
71
120
109
124
113
110
111

 

MIDCAP INVESTORS FISH IN A WELL-STOCKED POND
---- % With 12-Mo. Growth Above 20% ----
% With P/E Ratio
----- Below 20 -----
% With 12-Mo. EPS
Growth
Above
20% &
Trailing P/E
Below 20
% With Quadrix Scores Above 80
Index
EPS
(%)
Sales
(%)
Cash From
Operation
(%)
Est. EPS,
Current
Fiscal
Year
(%)
Trailing
P/E
(%)
Forward
P/E
(%)
Momen-tum
(%)
Value
(%)
Overall
(%)
S&P MidCap 400 Index
24
11
21
20
37
56
8
19
18
24
S&P 500 Index (large-cap)
17
10
18
14
50
66
8
16
24
27
S&P SmallCap 600 Index
18
15
18
19
30
49
5
18
16
19
Note: Quadrix scores are percentile ranks, with 100 the best.

The S&P MidCap 400 is a fertile hunting ground for new leaders in a variety of industries. Consider outsourcer Cognizant Technology Solutions ($52; CTSH), which was a member of the midcap index 10 years ago, with a market value of $3.23 billion and annual sales of $368 million at the time. Its market value has since risen ninefold.

MOVING ON UP
Below, we list notable S&P MidCap 400 stocks from five and 10 years ago that have graduated into the S&P 500 Index. Recommended stocks are in bold.
--- 5 Years Ago ---
------- Today -------
5-Year
Change
In Share
Price
(%)
5-Year
Annual.
Sales
Growth
(%)
Company (Price; Ticker)
Market
Value
($Bil.)
12-Mo.
Sales
($Bil.)
Market
Value
($Bil.)
12-Mo.
Sales
($Bil.)
Priceline.com
($1,251; PCLN)
3.2
1.9
66.2
6.8
1,488
29
Netflix ($365; NFLX)
2.5
1.4
22.4
4.4
750
26
Alliance Data Sys.
($273; ADS)
2.2
2.0
18.0
4.3
638
16
Helmerich & Payne
($108; HP)
2.4
2.2
11.7
3.4
375
9
 
--- 10 Years Ago ---
------- Today -------
10-Year
Change
In Share
Price
(%)
10-Year
Annual.
Sales
Growth
(%)
Company (Price; Ticker)
Market
Value
($Bil.)
12-Mo.
Sales
($Bil.)
Market
Value
($Bil.)
12-Mo.
Sales
($Bil.)
Cognizant Tech.
($52; CTSH)
2.9
0.4
31.6
8.8
814
37
Mylan ($49; MYL)
6.1
1.4
19.5
6.9
117
18
Valero Energy ($56; VLO)
7.8
38.0
30.1
138.1
270
14
Precision Castparts
($260; PCP)
2.8
1.8
38.0
9.5
1,079
18

Just five years ago, Helmerich & Payne ($108; HP) also belonged to the midcap index. Its fleet of advanced drilling rigs positioned H&P to become a leading player in the booming U.S. shale-drilling industry. Today its market value is nearly five times higher than five years ago, while sales have advanced at an annualized 11% clip. Both Cognizant and H&P have since graduated to the S&P 500 Index.

The following three recommended stocks seem capable of following the route taken by Cognizant and H&P. Another appealing midcap, Foot Locker ($47; FL), is reviewed in Analysts' Choice.

By entering 2014 with its backlog at an all-time high of $8.8 billion, B/E Aerospace ($89; BEAV) seems poised to gain share in the aerospace market in coming years. And it continues to gather momentum, with bookings for the three months ended March setting a quarterly record. B/E announced in March that it won seating contracts with seven airlines worth a total of about $600 million.

B/E Aerospace also continues its push into the energy-services industry, which could ultimately represent 5% to 10% of revenue. In March, B/E Aerospace agreed to pay up to $170 million to acquire Vision Oil Tools, a provider of rental equipment and services to energy drillers and producers.

B/E Aerospace raised its 2014 guidance for per-share earnings to $4.30 excluding acquisition-related expenses, versus its prior target of $4.25 and the consensus of $4.34 at the time of the announcement. Admittedly, the stock looks somewhat stretched at 20 times estimated 2014 earnings, 17% above its peer-group median. We are keeping close watch on the stock's valuation, but the outsized growth warrants a premium. B/E Aerospace is a Buy and a Long-Term Buy.


U.S. oil production is surging, and so is demand for railcars to haul crude oil to refineries. Both trends benefit Trinity Industries ($72; TRN), a leading maker of tanker cars. Sales climbed 15% in 2013, while cash from operations jumped 26% to $662 million. The railcar unit (48% of 2013 revenue) drove growth, its sales surging 38%. Trinity's other businesses include railcar leasing (15%), inland barges (13%), energy equipment (12%), and construction products (12%).

Trinity earns an Overall rank of 98, with scores above 90 for Momentum and Performance. Shares have rallied 32% in 2014, versus 2% for the S&P 1500 Index, yet earn an attractive Value score of 76. The stock trades at just 11 times projected 2014 earnings, a 46% discount to the median for the S&P 1500 industrials sector. Trinity is projected to grow per-share earnings 47% to $6.87 this year on 19% higher revenue. Trinity is rated Best Buy in Upside, our sister newsletter focused on small and midcap stocks.


Founded in 1882, UGI ($45; UGI) gives investors the unusual pairing of a propane distributor and a natural-gas utility. Among S&P 1500 utilities, the stock offers a rare blend of growth and value. Indeed, UGI is the only S&P 1500 stock in the sector with 2013 earnings per share up more than 20%, consensus profit estimates for 2014 targeting more than 10% growth, and both trailing and forward P/E ratios below 18.

UGI owns a 26% stake in propane distributor AmeriGas Partners ($43; APU), which recently drew the ire of regulators. The Federal Trade Commission has accused AmeriGas and Blue Rhino of colluding against Wal-Mart Stores ($77; WMT) by allegedly agreeing to reduce the amount of propane in their tanks without changing the price. At the time, AmeriGas and Blue Rhino controlled 80% of the market for wholesale propane exchange tanks. UGI investors seem to have shrugged off the concerns; the stock closed at an all-time high March 31.

Despite their solid year-to-date total return (10%), UGI shares earn a Value rank of 80 and trade below their sector medians for trailing earnings, sales, and cash flow. UGI, yielding 2.5%, is a Buy and a Long-Term Buy.

RECOMMENDED STOCKS IN THE S&P MIDCAP 400 INDEX
We highlight below 15 recommended midcaps, stocks with market capitalizations between $2.5 billion and $12 billion. Stocks listed in bold are covered by our sister newsletter, Upside, which focuses on smaller companies.
Stock-
Market
Value
($Bil.)
--- Last 12 Months ---
Est. EPS
Change,
Curr. Yr.
(%)
---- P/E Ratio ----
------ Quadrix Scores ------
Company (Price; Ticker)
Sales
($Bil.)
Sales
Chg.
(%)
EPS
Chg.
(%)
Trailing
Forward
Momen-
tum
Value
Overall
Industry
Alaska Air Group
($94; ALK)
6.6
5.0
7
24
24
17
14
94
73
99
Airlines
Alliant Techsystems
($142; ATK)
4.6
4.6
1
25
35
14
14
89
65
94
Aerospace
B/E Aerospace
($89; BEAV)
9.3
3.5
13
24
23
24
20
87
43
84
Aerospace
Bally Technologies
($65; BYI)
2.6
1.1
12
26
26
17
15
93
80
92
Casinos & gaming
Foot Locker ($47; FL)
7.0
6.5
5
13
12
17
15
82
80
99
Apparel retail
GATX ($68; GMT)
3.2
1.3
6
20
14
20
17
88
59
89
Trading cos.
HanesBrands
($78; HBI)
7.9
4.6
2
49
21
20
16
60
54
84
Apparel 
PTC ($36; PTC)
4.3
1.3
3
44
15
28
17
87
56
92
Applic. software
Raymond James
Financial ($56; RJF)
7.9
4.6
10
10
10
19
17
68
70
78
Invest. banking
Skyworks Solutions
($38; SWKS)
7.2
1.8
13
42
18
23
14
95
63
99
Semiconductors
Thor Industries
($64; THO)
3.4
3.2
2
18
20
21
19
60
48
78
Auto manufac.
Trinity Industries
($72; TRN)
5.5
4.4
15
47
45
15
11
97
76
98
Const. machinery
UGI ($45; UGI)
5.3
7.5
9
25
11
17
17
68
80
82
Gas utilities
United Rentals
($96; URI)
10.2
5.0
20
42
27
24
15
92
65
98
Trading cos.
Valmont Industries
($151; VMI)
4.1
3.3
9
27
(5)
14
14
52
94
95
Indust. machinery

 


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