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Pity the poor mid-caps. Many investors tend to focus on large-cap blue-chip stocks, while more aggressive investors often seek out robust potential upside among off-the-radar small-cap stocks. Stuck in the middle: Mid-cap stocks — which I define as having market values between $1 billion and $5 billion– often fall into the cracks. And that’s a shame because these companies often represent the stability of large caps and the potential for unappreciated value of small caps, as many of them are still not widely-known by most investors.
I went looking for the most interesting mid-cap stocks right now. I focused on companies that exceeded first-quarter profit forecasts by at least 30% (with earnings of at least $0.25 per share). After a deeper look, a few stocks in the group appear especially appealing right now.
Is it sustainable?
It’s important to remember the old investing maxim “one quarter does not a trend make.” Indeed, a company can show real strength in one period, thanks to industry pricing and volume trends, only to see a deep reversal in those factors just three months later.
Consider the case of U.S. Steel (NYSE: X). The steel maker missed estimates in the second quarter of 2011, blew past forecasts in the third quarter, once again badly lagged the consensus in the final quarter of the year — and just announced a very solid quarter to start the current year. Goldman Sachs analysts say the first-quarter results will be the high watermark for the year, and rates shares a “sell” with a $23 price target — roughly 15% below the current stock price. “We remain of the view that steel prices will be lower in 2H2012 and thus, steel price-sensitive companies like U.S. Steel would see a material deterioration in earnings in the latter part of the year,” they wrote in an April 24 note to clients.
On the other hand, any company that can top estimates while industry conditions remain challenging is likely to produce ever-stronger results as that industry starts rebound. As an example, check out Terex (NYSE: TEX), which provides a range of construction equipment (such as cranes, aerial lifts and other gear) that helps build roads, buildings and other infrastructure projects.
Terex really took it on the chin during the recent recession. Sales fell from $8 billion in 2007 to just $3.9 billion in 2008, leading to an 80% drop in gross profits to $297 million. The top line has bounced back up to a recent $6.5 billion in 2011, should exceed $8 billion this year and top $9 billion in 2013, according to Merrill Lynch. Meanwhile, after falling from $90 back in 2007 to a recent $23, shares trade for less than six times Merrill’s projected 2012 EBITDA. That multiple slips even lower if you anticipate an improving economy in coming years that boosts construction spending.
General Cable (NYSE: BGC) is another company geared up for an improving level of construction spending. The company’s utility-grade cables are used in office parks, submerged power line programs and general construction. General Cable is also a leading provider of communications network wiring that is deployed by phone companies. Shares had been slumping since last summer after a string of earnings disappointments, but industry conditions have now turned up, and a just-announced strong first quarter could be the start of a new trend.
Analysts anticipate only moderate 5% sales growth in 2012 and 2013 (to around $6.7 billion), but they also see a lot of operating leverage in the income statement. As a result, earnings per share (EPS) are expected to rise around 20% this year to around $2.60, and more than 30% in 2013 to around $3.40. Shares trade for less than 10 times that 2013 outlook, which may not even be the top of the cycle. Analysts at DA Davidson see shares rising form a recent $32 to $40, and that target price assumes shares will trade up to just six times projected 2013 EBITDA.
Risks to Consider: A slowing U.S. economy would make it a lot harder for these companies to exceed a rising level of expectations.
Action to Take –> A few companies on this list may be poised to put together a string of successful quarters. But as noted, don’t assume that a one-time profit surge can last. You need to dig into the factors behind the EPS beat to be assured that better-than-expected profits will be the case throughout the year.
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