Today I’m looking at two mid-cap companies whose growth has beaten all expectations over the last few years. Will these stellar performers continue to beat the market, or is a period of consolidation now on the cards?
Another strong set of figures
Few companies have outperformed expectations more regularly than J D Wetherspoon (LSE: JDW). The stock has risen by 45% over the last year alone, as Brexit-backing founder Tim Martin has continued to steer the pub chain successfully through worsening market conditions.
Today’s first-quarter trading statement is no exception. The group’s like-for-like sales rose by 6.1% compared to the same period last year. Management reported an underlying operating margin of 8.6% for the first quarter, significantly better than the equivalent figure of 7.7% reported for last year.
To improve its performance, the chain is pruning underperforming pubs. Six pubs have been sold since the start of August, while two new sites have opened, out of a total of 10-15 planned for the year.
This process should help to protect the company’s cash flow and margins. That’s important, as I believe the biggest risk facing equity investors is the group’s debt burden. This is currently running at 3.5 times earnings before interest, tax, depreciation and amortisation (EBITDA).
The firm says it is targeting a more conservative range of zero to two times EBITDA over the long term, but Mr Martin says he is happy with the current level of borrowing, given the low interest rate environment.
Time for another round?
Broker forecasts for 2017/18 put Wetherspoon’s stock on a forecast P/E of 19, with a prospective yield of just 1%.
The shares look cheaper when measured against free cash flow, which was 97p per share last year. That implies a price/free cash flow ratio of 12.9, which is very reasonable.
I don’t have the nerve to invest in Wetherspoon at current levels, but I’d certainly continue to hold if I owned the stock.
Even more outrageous
Back in 2015, the founders and management of online trading firm Plus500 Ltd (LSE: PLUS) were ready to accept a takeover bid of 400p per share.
A regulatory investigation led to the failure of this bid, and the company has continued as a standalone business. This hasn’t stopped it delivering runaway growth. Plus500 stock recently hit an all-time high of 1,050p, after the group advised investors to expect full-year results “ahead of expectations”.
Earnings have kept pace with the share price, and the stock still only trades on nine times 2017 forecast earnings of 112p per share. A total dividend of 67.6p is expected this year, giving a tempting yield of 6.7%.
Not without risk
I have to admit that I don’t understand why Plus500 is so much more profitable than its rivals.
I’m also concerned that the group’s performance metrics seem to imply that many of its customers are only active for a short time. That suggests to me that the group could be hit by planned tighter restrictions on leverage for inexperienced traders, who are generally net losers.
However, these new rules remain in the future and may not be as severe as expected. For now, Plus500’s cash generation provides ample support for its valuation and dividend. It probably makes sense to take some profits, but I wouldn’t sell just yet.