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JP Morgan says 2021 is a ‘stockpickers’ paradise with big money-making opportunities’ – Here’s the firm’s 22 ‘highest conviction’ small-cap investment ideas

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Traders in the S&P 500 stock index futures pit signal offers near the close of trading at the Chicago Mercantile Exchange May 23, 2007

  • JP Morgan equity analysts are saying 2021 will remain ‘a stockpickers paradise’ in a research note.
  • The analysts are bullish on smid-cap stocks based on their analysis of the state of the market.
  • We list the firm’s top 22 investment ideas in the small- and mid-cap space.
  • Visit the Business section of Insider for more stories.

At the start of the year, JPMorgan equity analysts advised investors there would still be upside opportunities in the market, despite what could be a “rocky” first quarter with COVID-19.

What transpired was a very strong two-month rally that built on the soaring gains in the small- and mid-cap market over the previous year. The Russell 2000 index has gained nearly 16% so far in 2020, compared with a 4.5% gain in the S&P 500.  

Despite the already impressive gains, equity research analyst Eduardo Lecubarri and his team said they were still bullish on small-to-mid cap stocks, which they define as having a value of between $100 million and $5 billion, in a February 4 research note.

“We stick to our view that 2021 will be a stockpicker’s paradise with big money-making opportunities if you are willing to go against the grain,” Lecubarri said.

Read more: It could take just 2 catalysts for pockets of speculation to snowball into a widespread bubble, one global strategist says. He recommends 3 ways to capitalize on this frothy environment.

But Lecubarri said the team’s smid strategy framework analysis suggested a recovery that would benefit so-called “smid-cap” stocks.

The strategy framework is an objective view on the state of smid-cap stocks. It analyzes a range of components from the macro, to fundamentals and valuation, to sentiment and technical analysis.

The framework suggested a recovery that should result in margin expansion pushing smid-cap earning growth into double digits, Lecubarri said.

“One of the reasons we remain constructive about SMid is that, while consensus expectations for 2021 may prove optimistic, 2021’s YoY expansion in margins should drive double-digit earnings growth, as economic activity recovers, commodity prices remain subdued, and wage inflation slows for a while,” Lecubarri said.

This is one of the main reasons the analysts are bullish on smid-caps, even though there could be pullbacks in the rest of the first quarter. 

SMid-cap stocks are a “stockpicker’s paradise” because some are overvalued, while others show over 50% recovery upside, Lecubarri said.

“Valuation dispersion remains near record highs implying big upside opportunities can still be found,” Lecubarri said.

Positioning

In the note, Lecubarri broke down the firm’s views on positioning in smid-cap market. Overall the firm is overweight small-and-mid cap stocks compared to large-cap stocks.

JPMorgan is overweight in smid-caps in the UK, Ireland, Finland, Denmark, Germany, Austria, Switzerland and the Netherlands.

“We remain OW the UK, but you have to pick your battles. What we mean is that, while the broad UK SMid market may not be as clear a ‘BUY’, given the degree of uncertainty brought about by Brexit, we do see plenty of opportunity at the stock level within an overall picture that is not all bad,” Lecubarri said,

The bank is neutral, meanwhile, on US smid-caps.

“The region benefits from its more organized and faster vaccination plan, which should yield a more speedy economic recovery; but it suffers from a) the most leveraged corp balance sheets, b) lower FCF, and c) less recovery upside as it has suffered far less than Europe from COVID-19 on EPS, or GDP;” Lecubarri said.

Investors should focus on valuation and run away from pricey multiples, Lecubarri said. And when looking at sectors think about recovery and valuation. Look for firms with solid balance sheets and that are not structurally damaged. 

“This takes us out of Energy, Financials, and Real Estate where we see structural headwinds, and out of Healthcare, Tech where valuations seem too demanding,”  Lecubarri said. “And so it leaves us OW Industrials, Materials, and Consumer (discretionary and staples… but preferring the former) in Continental Europe, while in the UK we are OW Materials, Industrials, Cons. Discretionary, Food, Beverages & Tobacco, and Utilities (the latter due solely to its valuation discount).”

Stock picks

Based on this outlook, the analysts provide a list of high-conviction ideas in the small-and-mid cap area. They also use this list to run a hypothetical long/short portfolio.

The ideas are broken down between investment opportunities and stocks to avoid.

The approach is a mixture of bottom-up and top-down analysis of over 17,000 smid-cap stocks globally. This means that not all the stocks listed as investment opportunities, or stocks to avoid, will be covered by JP Morgan equity analysts.

Read more: UBS says buy these 20 discounted small-cap and mid-cap stocks expected to take off in 2021 – including one that could rally 60%

Lecubarri and team recommend investors look at the list as stock ideas, rather than a source of recommendations.

The team uses four fundamental thematic screens to help find the ideas with the smid-cap universe that align with their strategy framework views.

The screens are:

  • Better than bonds – Stocks with a last reported dividend yield greater than 5%.
  • Diamonds in the rough – Stocks that are still down more than 30% from this year’s February market highs, and have a ND/EBITDA less than three times.
  • Growth havens – Stocks that are in the top two quintiles of ROE and trailing EPS growth, while also trading below their industry average trailing P/E at present.
  • Growth shorts – Stocks in the top quintiles of trailing P/E and consensus EPS Yr+1 estimated growth.

We list the 22 investment opportunities in the smid-cap space highlighted by JP Morgan:

1. Arrow Global

Ticker: ARWGF

Sector: Finance

Rating: Overweight

Market capitalization: $530 million

Analyst comment: “Trading well below mkt multiples on fw numbers despite recent outperformance. Last year’s fund raising adds credibility. Econ downturn = better margins going fw as NPL supply increases.”

Source: JP Morgan

2. Bellway

Ticker: BLWYF

Sector: Buildings

Rating: Overweight

Market capitalization: $5 billion

Analyst comment: “It focuses on the two areas with OK fundamentals (high end & social housing). A grw story since 07 (rev x2, assets x2). Fortress net cash BS. Still down >30% from highs.”

Source: JP Morgan

3. DCC

Ticker: DCCPF

Sector: Oil refining & marketing

Rating: Overweight

Market capitalization: $7.8 billion

Analyst comment: “Down big despite resilient business, trading at a discount to broader mkt, with M&A potential due to unlevered BS (recent acquisition backs this). Parts of the business in structural decline but a slow one.”

Source: JP Morgan

4. DS Smith

Ticker: DITHF

Sector: Containers

Rating: Overweight

Market capitalization: $7.1 billion

Analyst comment: “Down big from its ’18 high, OK BS, a FCF Yld well > mkt, a solid growth trajectory (Sales up 3.4x since 07, EBITDA up 6,6x, NI up 8.7x); e-commerce ~20% of revs, and paper prices up from recent lows.”

Source: JP Morgan

5. Inchcape

Ticker: IHCPF

Sector: Distribution/Wholesale

Rating: Overweight 

Market capitalization: $3.6 billion

Analyst comment: “Good FCF + Solid BS + good theme (Auto sales to pick up YoY as economy recovers and electric vehicle alternatives become more plentiful). Still down big from highs / big discount to mkt.”

Source: JP Morgan

6. Vectura

Ticker: VEGPF

Sector: Medical 

Rating: Overweight

Market capitalization: $943 million

Analyst comment: Cheap and defensive 

Source: JP Morgan

7. Taylor Wimpey

Ticker: TWODF

Sector: Buildings

Rating: Neutral

Market capitalization: $7.8 billion

Analyst comment: “Cheapest of the quality housing plays in the UK. Margin expansion led to EBITDA grw since 07. BS now net cash vs highly leveraged in 09. Curr Value = Double digit FCF Yld on peak profits!”

Source: JP Morgan

8. Applus

Ticker: APLUF

Sector: Commercial services

Rating: Neutral

Market capitalization: $1.5 billion

Analyst comment: “>10% FCF in 19… down big from highs. Oil & Gas Grw Capex just 9% of Revs. Testing, Homologation, Certification could benefit from increased Gov regulation.”

Source: JP Morgan

9. ASTM

Ticker: ASTPF

Sector: Motorways

Rating: Not covered

Market capitalization: $3.4 billion 

Analyst comment: “Recovery play. Has underperformed despite business not structurally damaged. BS less leveraged than in the past. Valuations near trough and below mkt.”

Source: JP Morgan

10. Bpost SA

Ticker: BPOSF

Sector: Transport

Rating: Not covered

Market capitalization: $2.4 billion

Analyst comment: “Solid balance sheet ND/EBITDA 21E (Consensus) <1.0x, consistent free cash flow, strong dividend, valuation far below that of the Pan-European Smid, growth from acquisitions and potential margin expansion.”

Source: JP Morgan

11. L.D.C S.A

Ticker: 0RJ6.L

Sector: Poultry

Rating: Not covered

Market capitalization: $2.1 billion

Analyst comment: “Cheap staples with ~8% Oper FCF Yld ex grw capex. Still trading near its ’09 trough on P/E. Solid balance sheet and a steady business likely to benefit from depressed economic environment.”

Source: JP Morgan

12. Hamburger Haffen

Ticker: HHULF

Sector: Transport

Rating: Not covered

Market capitalization: $1.7 billion

Analyst comment: “Down big from ’19 high, solid BS, a FCF yield ~7%, and clearly exposed to a recovery in global activity levels.”

Source: JP Morgan

13. Maisons du Monde

Ticker: MODUF

Sector: Retail 

Rating: Overweight

Market capitalization: $814 million

Analyst comment: “A stock that is down big from highs, trading at a big discount to hist avg multiples, despite its solid balance sheet and the fact that it is structurally benefiting from COVID-19″

Source: JP Morgan

14. Motor oil (Hellas)

Ticker: MOHCF

Sector: Oil refining and marketing

Rating: Not covered

Market capitalization: $1.6 billion

Analyst comment: “Below hist valuations still, 10% FCF Yld. Solid and much improved BS.”

Source: JP Morgan

15. Navigator

Ticker: NVGS

Sector: Paper & related products

Rating: Not covered

Market capitalization: $2.1 billion

Analyst comment: “Recovery play with demand for paper moving higher YoY along with pricing. Pulp prices near troughs after 18 mths of down. Down big since 2019, despite solid BS and steady FCF generation.”

Source: JP Morgan

16. Schaeffler

Ticker: SCFLF

Sector: Auto parts

Rating:  Not covered

Market capitalization: $5.4 billion

Analyst comment: “Down big despite resilient business with solid operating momentum. Self help due to restructuring plan. FCF yld to move into double digits as capex drops to 6% of revenues. “

Source: JP Morgan

17. Talgo

Ticker: TLLGF

Sector: Machinery

Rating: Not covered

Market capitalization: $604 million

Analyst comment: “3.6 Bill order book = huge visibility + Decent FCF yld + recovery play after having corrected so much in 2019 for no reason. JV in UK show momentum and visibility. Solid BS. “

Source: JP Morgan

18. FLSmidth

Ticker: FLIDF

Sector: Machinery

Rating: Not rated

Market capitalization: $1.9 billion

Analyst comment: “Down big from highs, with a solid balance sheet and strong FCF generation. Among cheapest in the industry. Cement exposure hated and discounted but minging exposure should recover. “

Source: JP Morgan

19. Jazz Pharmaceuticals

Ticker: JAZZ

Sector: Medical

Rating: Overweight

Market capitalization: $8.5 billion

Analyst comment: “Solid grw story with a ~8% Oper CF Yld (ex grw capex). Oncology, Narcolepsy, Pain, Psychiatry… all structural grw mkts. 25 R&D proyects bring upside (5 life products).”

Source: JP Morgan

20. Hankook Tire

Ticker: 161390.KS

Sector: Rubber tires

Rating: Overweight

Market capitalization: $5.1 billion

Analyst comment: “Trading near the lowest multiples of tire companies. Down big from recent highs, solid balance sheet (ND/EBITDA <1x), steady FCF generation. A safer way of gaining exposure to autos.”

Source: JP Morgan

21. PAX Global

Ticker: PXGYF

Sector: Computers

Rating: Not covered

Market capitalization: $1.1 billion

Analyst comment: “Net Cash =40% of mkt cap. Valuations (ex-cash) near mkt lows. Resilient FCF yld of >6%. And growing fast!”

Source: JP Morgan

22. VTech Holdings

Ticker: VTKLF

Sector: Audio/video

Rating: Not covered

Market capitalization: $2.1 billion

Analyst comment: “Ex growth but an 8-10% Div Yld story with a net cash BS. “

Source: JP Morgan

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