Mid-cap stocks are often overlooked, but they offer something of a sweet spot: better-established and less risky than their small-cap cousins, but still not blanketed with analysis like the large-cap space, where it’s difficult to find an undiscovered gem.
In the past year, mid-cap stocks—defined as those with a market cap from $1.6 billion to $6.8 billion, according to S&P Dow Jones Indices—have trailed large-caps but have held up better than small-caps, meaning they’ve shown some resiliency without getting too pricey.
Investors looking into the space should consider an actively managed fund with a strong track record, such as the Carillon Eagle Mid Cap Growth fund (ticker: HAGAX). The fund, which has below-average fees of 1.12% but charges a 4.75% front-end load, earns four stars from Morningstar and has outperformed the Standard & Poor’s 500 index, the S&P MidCap 400, and its mid-cap growth peers over the past one, three, five, 10, and 15 years. It has returned more than 17% on an annualized basis over the past five years and is No. 7 in its Morningstar mid-cap growth category.
Portfolio co-managers Bert Boksen and Eric Mintz look for promising companies with accelerating earnings growth that aren’t well known—and then hold on to their winners. It helps that they also run the Carillon Eagle Small Cap Growth fund (HRSCX), as many of these small stocks that they know well can then “graduate” into the Mid Cap fund.
We asked the two managers to discuss their top stock picks.
Barrons.com:Tell me about a stock that exemplifies the fund’s holdings.
Boksen: Coherent (COHR) has been a great stock for us. We initially bought [the laser maker] back in 1998 in our small-cap portfolio at a price of about $19 a share. I had an interview with management back in September 2016, and they explained in great detail the opportunity they had in a new laser product that they had invested heavily in, which was enabling OLED glass to be manufactured. The stock at that time was about $106, and today it is trading at [more than $300]; since that meeting the earnings have exploded straight up. The backlog of orders is dramatically higher. The new Apple iPhone X has a brilliant screen made out of OLED, and Coherent lasers enabled that process.
Q:It was still in your top five holdings at the end of the third quarter, after the stock’s rally. Do you still think it’s a buy?
Boksen: The iPhone is just the first product. Now they are talking about foldable phones which can double their screen size, and you are going to have tablets, and beyond that it’s going to be used in automobile dashboards. Their capacity in the product is sold out until 2018, and they are adding incremental capacity for 2019. So they have a tremendous runway for growth for at least the next two to three years.
Q: Let’s talk about Waste Connections (WCN), a waste and recycling collector, which was your biggest holding at the end of the third quarter.
Mintz: Waste Connections is another one of our graduates from the small-cap fund into the mid-cap fund. The management team is by far the best in the industry. They’ve done a fantastic job of making very strategic highly accretive acquisitions focusing on markets where there is very rational competition and they can lead their margins higher. It is really more of a block-and-tackle story—all these compounders over time, due to their operational expertise, and also integrating underperforming companies, bringing them into the fold, and implementing their best practices to improve the overall efficiency.
Q:Cruise lines have been in the news lately because of this year’s strong hurricanes. Let’s talk about Royal Caribbean Cruises (RCL).
Boksen: Cruise lines have been benefiting from baby boomers retiring, people who love to cruise and go on multiple cruises. They are also benefiting from millennials who like to buy experiences as opposed to consumables. They are benefiting from new markets in China, in Cuba. You had a brief downturn because of the hurricanes, but they’ve rebounded very strongly. They are looking for a good selling season; the earnings are growing very, very nicely.
Royal Caribbean has a new 2020 plan where they expect to have double-digit earnings. For a frame of reference, today the estimates are for $7.40, and next year the estimates are $8.50. So the stock, despite being a great stock and having had a good run, trades at about 14½ times earnings.
Q: And you like it better than Carnival (CCL) or Norwegian Cruise Line Holdings (NCLH)?
Boksen: Royal Caribbean has done a good job at satisfying customers and getting repeat customers. Carnival maximizes the onboard spend, sometimes to the extent of giving the customers a bad experience. With Norwegian, there is a big overhang of private equity, and you also have big exposure to the Caribbean, whereas Royal is much more broad-based, and it certainly has done the best job in China.
Q:Now that we’re in the holiday season, all eyes are on retail. You own Burlington Stores (BURL). Do you think off-price retailers are better positioned than others?
Boksen: Burlington has been sensational. The off-price channel has been good for both Burlington and Ross Stores (ROST); TJX Co s. (TJX) has just stubbed its toes a little bit. Burlington is not a coat company anymore, and they are doing a good job in diversifying the product, particularly in housewares and jewelry. They have mid-single-digit growth in new-store sales. They have a chance for at least 20 basis points [0.20 percentage point] in margin expansion coming from the better product mix on the floor, and despite Burlington historically being the poorest-run company, they are making tremendous strides in their product mix, in rationalizing the store size, and in reducing their dependence on coats. It has resulted in some very good numbers and very good stock performance, and we think that still has a ways to run.
Q: So it can hold its own against Amazon.com (AMZN)?
Boksen: There is still a thrill of discovery—everyone loves to discover a bargain, and with the problems of the malls and the department stores, Burlington is able to buy merchandise at very attractive prices. Customers like to come in, and they may not come in for a specific item, but they want to see what they can get a deal on. The stores have been doing very well and have been able to compete very effectively with Amazon, certainly on price.
Q:Speaking of companies that have done well, you own semiconductor company Nvidia (NVDA), which is up 79% this year and now trades at $195.
Mintz: Nvidia was a name we put in the fund when it was a value stock; we bought it at $36.15 in April 2016. But it has played out beyond our wildest expectations. I think the focus on the Bitcoin angle is a little bit overdone. There certainly is concern regarding the sustainability of the business that is coming from cryptocurrencies, and it really distracts from the tremendous growth that they are seeing in the data-center [business]—and obviously automotive is a huge opportunity longer-term.
Q: So it still looks attractive even after its rally?
Mintz: Yes, it is still a core holding.
Q: Progressive (PGR), the insurer, is a relatively new position. Tell me what attracted you there.
Boksen: Progressive was a cheap stock. We think it does very, very well in the car insurance business. There is a lot of opportunity in competing as a low-price insurer in that space against the higher-priced [options] where you have to use an agent. Progressive doesn’t use sales agents and is able to offer very attractive pricing, and that was a key element of our purchase decision.
Q: You also own Electronic Arts (EA).
Mintz: In the videogame space we are seeing a massive shift as more people download videogames as opposed to buying the physical content, which is having a very positive impact on EA’s margin structure. During the last quarter we got data points for all three of the major publishers—Electronic Arts, Activision Blizzard (ATVI), and Take-Two Interactive Software (TTWO)—that suggested an acceleration in the trend. That’s the first key driver. The second key driver is a shift toward microtransactions within the game: EA is really generating a much higher percentage of revenues from recurring sources such as these.
Q: Any other stocks you’d like to talk about?
Mintz: I would mention just quickly, on the energy side, Diamondback Energy (FANG). In our opinion, it’s the best way to play higher oil prices, or even lower oil prices, given that they are absolutely the low-cost producer, growing production quite nicely in the Permian Basin because they have really some of the best acreage there. They’re also staying within cash flow, which is truly the gold standard in that industry.