Cheap and resilient British mid-caps offer compelling long-term potential

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While larger British companies have been relative outperformers in the turbulent market environment of the last few years, medium-sized and small companies, which are trading at historically low valuations, currently offer a compelling opportunity for long-term investors.

There are numerous examples of resilient medium-sized and small UK companies which, in addition to serving as innovators and disruptors in their respective industries, have demonstrated attractive qualities in a period of macroeconomic uncertainty and volatility. These include companies with competitive pricing power and strong balance sheets, but also those with the capacity to grow their market shares.

To identify these businesses, we take a research-driven approach, meeting more than 350 management teams a year in order truly to understand the businesses within our sector and what makes them tick.

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This helps us to spot the highest-quality businesses that are capable of adapting to the changing environments in which they operate. While there is naturally nervousness around the near-term outlook, we have a positive view, as expressed by the portfolio’s 10% gearing, and are excited by the opportunities that we see.

Capitalising on a changing market

One example is Telecom Plus (LSE: TEP), the multi-utility provider to UK consumers. Changes in the structure of the energy-supply market – including a hugely reduced set of competitors – have enabled Telecom Plus to accelerate its customer-acquisition strategy substantially and have underpinned the company’s growth.

We expect Telecom Plus to continue to perform well in a range of environments owing to its structural competitive advantages: the ability to leverage a single fixed-cost base across multiple utility product lines, and a unique partner-distribution model.

Dunelm (LSE: DNLM), the UK’s market leader in homewares, has not only weathered adverse conditions, but also thrived despite a tough environment for household spending. Although lower disposable incomes have made life more challenging for many retailers, we are optimistic about Dunelm’s growth prospects. They continue to be driven by an improving omni-channel customer proposition that is yielding ongoing market-share gains. We think that Dunelm could emerge from this difficult economic period with an even stronger competitive position and greater earnings power.

Customer service is the key to success

Finally, a long-term success story in the technology sector is software and hardware reseller Softcat (LSE: SCT). As a supplier of technology products and infrastructure, Softcat knows that customer service is key to standing out from the competition.

The firm’s focus on maintaining its unique culture, including driving employee engagement and running a highly successful graduate-recruitment programme, has helped it deliver strong and sustained growth.

While the pandemic saw the rapid growth of many interesting technology companies that then lagged in a post-lockdown environment, Softcat has continued to demonstrate impressive growth in a shifting landscape of different operating environments.

The company is well placed to emerge with even stronger customer relationships and will have gained significant numbers of new clients with the rise of hybrid working.

Guy Anderson is manager of the Mercantile Investment Trust