UK mid-caps are in “a sweet spot”, Reuters argued last week, when the news agency also pointed out that “Ladbrokes (LSE: LAD) was up 9.9% and was the top mid-cap performer followed by up-market London-focused homebuilder Berkeley Group (LSE: BKG) (up 8.9%).“
I think mid-caps stocks could offer more attractive returns than those of larger companies at this economic juncture, but if I were to choose two names in those sectors, it would be Betfair (LSE: BET) and Persimmon (LSE: PSN).
Ladbrokes vs Betfair
With Ladbrokes I feel you’d add volatility to your portfolio, while with Betfair you’d be betting on a nice growth story. Ladbrokes is up 3% this year, and its most appealing feature is a management reshuffle, which has been discussed for a long time but is actually taking place right now. Its online strategy doesn’t seem to be working, but Ladbrokes remains a valuable brand with a decent infrastructure network.
That said, it doesn’t strike me as being an incredible value opportunity based on forward earnings multiples in the region of 18x. New management may have to consider how to deal with capex requirements and dividends if core cash flows continue to deteriorate — as it has been the case since 2012.
Moreover, it’ll take time to implement operational changes and there are better options, such as Betfair, whose shares are up 60% this year, and has long been one of my favourite picks in the sector.
Is it time to take profit, though?
Betfair reports full-year results in mid-June, and I’d hold onto it until then, at the very least. Revenues, earnings and dividends are nicely growing, and are expected to grow for some time — that’s reflected in a forward valuation that stands at more than 30x earnings.
Management is focused on the operations, which need less capex than at some of its rivals, while the balance sheet is strong. I would not be surprised if Betfair decided to raise some debt to back its expansion plans and boost returns.
Berkeley vs Persimmon
“Thomson Reuters UK Homebuilding index up 6.3% at a record high & on course for its biggest one-day rise in about to years,” was another headline from Reuters at the end of last week.
A bet on growth in London and the South East, Berkeley stock rose a lot since it shrugged off concerns over Labour’s mansion tax, but this remains one of the less appealing equity investments in the sector, and I prefer Persimmon because of its geographical reach and a valuation that points to more upside than downside based on the two companies’ levels of core profitability.
Berkeley stock is up 11% in 2015, with most of the gains in the last few days of trade. That’s a performance in line with that of Persimmon so far this year, but Persimmon offers a more solid risk/reward profile.
Neither Berkeley nor Persimmon are incredibly expensive based on their relative valuations, but while core margins and cash flow are expected to grow at Persimmon, the pressure could build at Berkeley.
With Persimmon, you’d also be betting on rising returns from higher capital returns to shareholders, which appear to be on the cards. That said, both companies offer stellar forward yields, efficient use of capital as well as clean balance sheets — one caveat is that Berkeley’s dividend is less solid, though, based on its cash flow profile.
