Fund Managers’ Favourites: Mid-Caps Under the Microscope

AXA Framlington fund manager Chris St. John discusses his favourite mid-cap investments, including some well-known high street names

Alanna Petroff 3 December, 2012 | 7:00AM
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In the video series, "Fund Managers' Favourites", Morningstar speaks with UK-based fund managers to learn about their top investment picks. In this video, Morningstar journalist Alanna Petroff speaks with Chris St. John, a fund manager at AXA Framlington, to talk about three promising mid-cap companies.

Securities Mentioned in this Video:

AXA Framlington UK Mid-Cap Fund
Ashtead Group (AHT)
William Hill (WMH)
Sports Direct International (SPD)

Video Transcript:

Alanna Petroff: Past ‘Fund Managers' Favourites’ videos examining UK mid-cap picks have been very popular in the past. So we’re back with more now. I’m joined by Chris St. John from AXA Framlington. He runs the AXA Framlington UK Mid Cap Fund and we’re going to speak about mid-caps.

So, Chris, thank you very much for coming in.

Chris St. John: Welcome.

Petroff: Now, let’s talk about why you’ve invested in mid-caps: you could have invested I supposed anywhere as a fund manager, why did you pick mid-caps?

St. John: Yeah, this is a very dynamic part of the market. It gets rebased quarterly, so the underperforming companies fall out of the bottom and the very good performing small-cap companies come into the bottom and into the index itself. In addition, in times of mergers and acquisitions, this is an area of the market that typically gets targeted. But moreover, FTSE 250 stocks tends to have faster growing earnings per share than their larger counterparts, typically backed by cash flows, and as a consequence, dividend growth tends to be superior to large-caps.

Petroff: Okay. So, let’s talk about your top three picks that we have right now. We have Ashtead Group, William Hill and Sports Direct International. So let’s start with Ashtead Group. That seems to be a market favourite these days. Why do you like Ashtead?

St. John: Yeah, Ashtead is a plant hire company. It’s exposed to the US predominantly and the UK as well. Particularly of interest to me is the US business currently. It’s a plant hire company and what it's really benefited from is the lack of credit availability in the market. It went into the downturn with a stronger balance sheet than its competitors. At the time when the plant hire sellers and manufacturers couldn’t make any sales, it had money, was able to do very good deals … as a consequence, it’s ended up with a much younger fleet than its competitors.

The end markets are stable and I think what their client base has recognised is that there is very little point tying up capital in diggers and dumpers rather than renting them. So, the outsource model in the US is starting to accelerate and that is to the benefits of Ashtead as well.

Actually looking forward, and why it remains interesting is, we are now starting to see really good pick up in non-residential construction and residential construction in the US, and this company is very well set to benefit from that.

Petroff: Okay. Moving on now to William Hill, I have not had this as a top pick in the past, why do you like William Hill?

St. John: Yes, it’s perhaps a little bit different. It's known for its high street license betting offices. What I think is of particular interest really is not necessarily the legacy business, but it's moving itself more into an online business, which is much more technology driven. By moving into the online space its actually opening up its geographies that it addresses, so it’s becoming a much more international business, much more technologically focused, which means it can scale, therefore on lower levels of capital, return on capital employed and shareholder return should benefit from that.

In addition, there are some very interesting potential corporate transactions around. It's looking at Sportingbet at the moment, which would take it into Australia. In addition, it has a joint venture with a company called Playtech and if it buys in the minority, which is being rumoured, then that could be very earnings enhancing as well.

Petroff: Okay. The last company, your last top pick, is Sports Direct International. Now, I have some doubts about whether this area generally is somewhere that I’d want to be. So convince me. Why would you want this area and this company?

St. John: Yeah, I’ve chosen just a straight retailer here. Now, this is not necessarily making a call that the end-market demand in terms of UK retail spend is going to takeoff. But this is a classic example of corporate Darwinism. This is a company that is taking increasing market share in the UK. It's now the market leader by turnover and operating profit, and a lot of that has come about because of the demise of the competition. So, this has taken increasing, increasing marketshare as competitors have fallen by the way side.

In addition, that is reflective of the fact that it is a very well-managed business. Great attention to detail. But it’s not just the high street that’s of interest. They’ve got a growing, again, Internet business, which is growing very rapidly and nationally. They are looking to expand internationally in Europe with physical shops as well. But in addition to that, Sports Direct owns and manages a number of brands and it has taken those brands and promoting them not only domestically, but internationally as well, particularly in places like the US.

Petroff: Now, let’s talk about the key risks for each of these companies because there is no company without its risks. We’ll start with Ashtead Group. What’s the key risk there?

St. John: I think the risks to this company are twofold. One is a collapse or significant reduction in construction spend over in the US. The second is a slightly stranger one, and that is that this company is making very high returns on capital at the moment and as the industry dynamics pick-up and residential construction grows in the United States, the chances are it will attract more capital to this area, and over time we are going to erode the capital returns that Ashtead can make.

Petroff: Now, moving on to William Hill. What’s the key risk there?

St. John: The key risk here for me is regulatory risk. They work within a very regulated framework, which is driven by governments ultimately. Governments will decide the upside and downside within a particular framework that this company can make.

Petroff: And for Sport Direct International, what would be the key risk there? 

St. John: Sports Direct can be twofold: one is a significant deterioration in UK consumer spending, although it feels fairly stable at the moment, and the second really is a classic cliché within this industry that ‘retail is detail’, but if you take the online business, for example, they are doing thousands of transactions that are very small in value and, as a consequence, it could be very easy to lose control of that business. So, for me it’s making sure that they keep very tight control of the supply chains and the customer service as well.

Alanna Petroff: Thanks very much for joining me today. That was Chris St. John from AXA Framlington and I’m Alanna Petroff. And if you wanted to check out any more information about online gaming we have another ‘Fund Managers’ Favourites’ with top picks that’s just below this video. Thanks for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Ashtead Group PLC4,120.00 GBP0.00Rating
AXA Framlington UK Mid Cap R GBP Acc279.64 GBP1.28Rating
Frasers Group PLC689.50 GBP0.00

About Author

Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.