While the market has rallied from the lows in early February, it is still trading well below the all-time highs printed in January. You combine the market pullback with earnings growth that is rising, and forward price-to-earnings ratios have fallen considerably. In fact, some of the forward numbers are as low as in 2016. While not cheap on a historical basis, they are much better values for the first time in a long time.
One area that looks particularly enticing is the mid-cap arena. Members of the Russell Midcap index have a market cap of $8 billion to $10 billion, with a median value of $4 billion to $5 billion. So they are large enough to have liquidity but small enough to be nimble. Best of all, they are currently the cheapest of all, trading at about 16.8 times forward earnings estimates.
We found five of the bigger members, which are among the largest holdings in the Russell Midcap index, that are rated Buy at Merrill Lynch. All make good sense for growth portfolios looking add mid-cap exposure.
Ciena
This company posted very strong earnings this week and took the sector higher. Ciena Corp. (NASDAQ: CIEN) is a vendor for high-capacity optical transport and Ethernet switching equipment to carriers, enterprises, cable operators and governments. It specializes in transitioning legacy communications networks to converged, next-generation architectures capable of efficiently delivering a broader mix of high bandwidth services.
The company’s Converged Packet Optical segment offers networking solutions optimized for the convergence of coherent optical transport, Optical Transport Network (OTN) switching and packet switching. Its products comprise the 6500 Packet-Optical Platform, 5430 Reconfigurable Switching System, CoreDirector Multiservice Optical Switches and OTN configuration for the 5410 Reconfigurable Switching System.
Top analysts feel that Verizon’s metro 100G buildout will be a focus for 2018, and the company could see catch-up spend from the now combined Centurylink. In addition, the new Waveserver products likely will continue to ramp as additional customers are added.
The Merrill Lynch price target for the shares is $28, and the Wall Street consensus target is $26.96. The shares closed trading on Tuesday at $25.71 apiece.
Nabors Industries
This company provides drilling and rig services, and some feel it could be a takeover target. Nabors Industries Ltd (NYSE: NBR) owns and operates the largest land-based drilling rig fleet in the world, and it is a leading provider of offshore platform workover and drilling rigs in the United States and select international markets. Revenues in 2016 were $2.23 billion.
Nabors markets approximately 400 rigs for land-based drilling operations in the United States, Canada and approximately 20 other countries worldwide, and 41 rigs for offshore drilling operations in the United States and internationally.
While the stock has rallied off the lows, Nabors is still down over 50% from highest levels posted a year ago. This concern has been exacerbated recently by a softer-than-expected third-quarter earnings report and focus on 2018 non–cash deferred revenues. While most don’t see a quick fix for the company, the worst surely looks to be over.
Merrill Lynch applauded the company’s debt deal completed earlier this year:
Nabors took advantage of attractive credit market conditions with an $800 million debt offering to address near-term maturities. The offering removes an overhang on the stock by addressing its maturity with refi rather than prior plans to use the revolver. We remain at a Buy rating and feel the company should be a key beneficiary in a $60 barrel oil environment.
Nabors investors are paid a 3.4% dividend, though that may be lowered going forward. Merrill Lynch has a $10 price target, while the consensus price objective is $9.10. Shares closed well below those levels Tuesday at $7.08.
Ross Stores
This discount retailer continues to be a favorite with cost-conscious consumers looking for the top brands and value. Ross Stores Inc. (NASDAQ: ROST) is the second largest off-price retailer in the United States. It operates about 1,350 stores under the Ross Dress for Less banner and over 200 stores under the dd’s DISCOUNTS brand. Both brands target women and men between the ages of 18 and 54.
About 75% to 80% of the company’s customers are females shopping for themselves or family members. Ross targets customers from middle-income households, while dd’s targets customers from more moderate income households.
Shareholders are paid a small 0.82% dividend. The $94 Merrill Lynch price objective compares with a consensus target last seen at $73. The stock closed most recently at $80.51 a share.
Royal Gold
This is a solid stock for investors looking for a gold presence with somewhat less risk. Royal Gold Inc. (NASDAQ: RGLD) is a precious metals royalty and stream company engaged in the acquisition and management of precious metal royalties, streams and similar production-based interests. The company owns interests on 193 properties on six continents, including interests on 38 producing mines and 24 development stage projects.
Many on Wall Street feel that the company is very undervalued when compared to its sector peers. Backed by three new or expanding assets, Royal Gold’s revenue could grow by 13% to nearly $500 million by fiscal 2019. Royal Gold’s strong liquidity position also means it can compete for royalty and stream acquisitions.
The company posted in-line fiscal second-quarter results and the analysts said this:
Fiscal second quarter 2018 revenue was 7% higher year-over-year at $114.3 million, driven by Andacollo, the Wassa/Prestea stream, and Rainy River. The company is improving its net debt & liquidity profile by focusing on paying down debt.
Shareholders are paid a 1.2% dividend. Merrill Lynch has set its price target at $98. The posted consensus target is $94.75, and the shares closed Friday at $83.56.
WPX Energy
This is a smaller capitalization company with solid upside potential and is another top Permian Basin play. WPX Energy (NYSE: WPX) is an independent oil and natural gas exploration and production company, engages in the exploitation and development of unconventional properties in the United States. Its principal areas of operation include the Permian Basin in Texas and New Mexico, the Williston Basin in North Dakota, and the San Juan Basin in New Mexico and Colorado.
WPX is a premier Permian-levered operator with sector leading debt-adjusted cash flow growth supported by strong execution in the core Delaware, all while trading at a Williston Basin valuations primarily due to its relatively high financial leverage.
WPX offers differentiated upside in a recovery case based on its asset quality/productivity and debt leverage. The company is the largest acreage holder of the publicly traded mid-caps and may have pound-for-pound the best position in the Delaware Basin.
The Merrill Lynch price target is $19. The consensus price objective is $19.58, and the stock closed Tuesday at $14.55.
Five mid-cap stocks all have Buy ratings at Merrill Lynch, and they can provide investors with exposure to the mid-cap arena. All make sense for investors looking for growth that have a little risk tolerance.
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