The mid-cap FTSE 250 index has outperformed the mature megacaps of the FTSE 100 over the long term and is a popular hunting ground for investors looking for stocks with high grow potential. Of course, not all mid-caps turn out to be big winners. Buying the right stocks at the right price is the key to outperformance.
Funerals specialist Dignity (LSE: DTY) has seen its shares crash more than 50% since the start of the year, due to a recent profit warning, while those of consumer goods group PZ Cussons (LSE: PZC) are little changed since the markets re-opened for 2018. Today, I’m discussing the investment outlook for half-price Dignity and full-price PZ Cussons.
Short term and long term
Back in September, I penned an article explaining why I’d buy PZ Cussons instead of the FTSE 100. Despite the shares having made no headway for a good number of years, I was confident in the company’s long-term prospects, due to good management, a strong stable of brands and extensive exposure to emerging markets.
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Cussons today released its half-year results. These were a little disappointing in that while revenue increased 1.9% (and 3.3% at constant exchange rates), underlying operating profit fell 10.3% and earnings per share (EPS) by 11.4%. The company saw strong growth in profitability in some areas of its business (notably in Asia) but this was insufficient to offset the impact of “very tough trading conditions” for some of its categories in the UK (washing and bathing) and Nigeria (milk and electricals).
Management has already taken steps to improve performance in these areas but I don’t see a quick return to earnings growth. Nevertheless, I think 19.9 times trailing 12-month EPS of 16.11p at a share price of 320p is reasonable value for a great business. For the reasons mentioned earlier — plus a strong balance sheet, giving scope for earnings-enhancing acquisitions — I continue to rate the stock a ‘buy’ for the long term.
The reaper calls for Dignity
Despite having some doubts about Dignity’s low equity/high debt structure, the company offered exposure to a business sector that wasn’t otherwise represented in the FTSE. And its principal businesses seemed attractive in theory: funeral charges could be increased without too much resistance, as they generally came out of the deceased’s estate, while crematoria gave the business utility-like qualities.
As the company knocked out year after year of consistent earnings and dividend growth, I made the mistake of growing rather complacent about looking beyond the headline numbers. The folk at start-up funeral comparisons website Beyond didn’t make the same mistake. Last September, when Dignity’s shares were trading at 2,242p, they became short sellers of the stock and published a 13,000-word report title “The Reaper Calls for Dignity”, arguing that the business model was unsustainable and the company grossly overvalued.
They were bang on the money, because Dignity has slashed its simple funeral prices, frozen its traditional funeral prices, warned that profits for 2018 will be “substantially below the market’s current expectations,” and seen its shares crash to 880p. I reckon the fall doesn’t reflect much more than the likely fall in earnings. With no real visibility on the long-term result of the pricing reset and also with that low equity/high debt structure I mentioned earlier now raising its ugly head, I view Dignity as a stock to avoid at this time.
