Three undervalued mid-cap stocks with attractive prospects

Watches of Switzerland ended 2021 as one of the biggest risers in the FTSE 250

(Image credit: © Eugene Gologursky/Getty Images for Haute Living)

The UK mid-cap equity market is filled with cutting-edge companies and exciting investment opportunities, many of which are more exposed to future growth drivers than larger companies in the FTSE 100.

However, the past few years have been a mixed bag for mid-cap stocks, with market uncertainty affecting domestically focused stocks particularly hard. Recent supply constraints have also led to a surge in inflation, which will no doubt remain a key focus for markets. Nevertheless, long-term performance has been healthy. Today, there is recognition that mid-cap UK companies are substantially undervalued, which could offer an attractive buying opportunity.

Watches of Switzerland – inflation-hedging through luxury retail

Despite a decline in overseas sales during the pandemic, luxury retailer Watches of Switzerland (LSE: WOSG) ended 2021 as one of the biggest risers in the FTSE 250, having gained almost 140% and trading more than four times its 2019 offer price. Consensus forecasts are for revenue in the coming 12 months to be more than double its pre-pandemic peak and earnings to increase almost four-fold. This is bolstered by the brand’s inflation-proofing potential – luxury watches are durable assets with higher demand than supply, and retailers can pass on cost pressures to their largely price-insensitive base of customers.

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The retailer’s long-term growth prospects also look attractive. Sales of luxury watches in the US are 40% lower per capita than in the UK, providing Watches of Switzerland with a potential growth opportunity. The company has also just made its first foray into the $14bn European luxury watch market, thanks in part to its strong relationships with suppliers.

Dunelm – a cash-rich homeware champion

Dunelm (LSE: DNLM) is a leading homewares retailer with a long-standing reputation for offering high quality products at a reasonable price. It has consistently grown sales, predominantly through market-share gains. The company is differentiated by its scale, expertise and a supplier network that has been built up over many years. The refresh of its web platform in 2019 further enhanced its customer service offering and enabled it to produce excellent results during the pandemic.

The company is continuing to take market share across its multichannel offering while also expanding into adjacent categories, such as furniture. This, along with a store rollout programme, should enable it to continue growing the topline for many years to come. Dunelm has a net cash balance sheet and strong cash generation. This has resulted in two special dividends to shareholders within the last year alone – a trend we expect to continue.

Alpha FX – setting higher standards in FX

Alpha FX (Aim: AFX) provides foreign exchange services to corporate clients who are undertaking cross-border transactions with customers or suppliers. These services have seen increasing demand as the global economy has become more integrated in recent decades.

Alpha FX has a technology- and customer service-led approach in what has historically been a poorly-served sector, which has helped grow its client base ten-fold and revenue per client five-fold in the last ten years. Clients are supporting it in setting-up across the globe, which should continue to drive revenue growth. Its results have consistently beaten market expectations since it floated in 2017.

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Katen Patel manages the JPMorgan Mid Cap Investment Trust