3 Fundamentally Sound Mid-Caps to Keep on the Watch List

Key Points

• The U.S. mid-cap asset class has a 2.5% edge on its large cap counterpart heading into the final months of the year.
• Huntington Ingalls has a surprisingly sturdy balance sheet and may keep drifting higher.
• BJ’s Wholesale has all the markings of a long-term winner.
• F5 reports fiscal Q4 results on October 25th.

The U.S. mid-cap asset class is holding up relatively well this year. As measured by the S&P 400’s year-to-date return, the group has a 2.5% edge on its large-cap counterpart (the S&P 500) heading into the final months of the year. 

With the economy likely to enter 2023 on shaky ground, fundamentals should matter a lot. The days of fundamentally flawed meme stocks making parabolic runs appear to be long gone. Today’s market appears to be a more rational one — one in which companies with strong income statements and balance sheets are stealing the show.

The mid-cap space is a great place to find less prominent names with the financials to outperform. Such companies are not just better equipped to weather the storm but also operate from a position of strength (as opposed to playing catch up) when economic conditions improve. 

Watch lists rooted in solid fundamentals should include these three stocks.

Does Huntington Ingalls Stock Have More Upside? 

Huntington Ingalls Industries, Inc. (NYSE: HII) is up 34% this year and quickly closing in on its January 2020 record high. The sustained buying activity in the defense sector stock relates to heightened geopolitical tensions, but there’s more to the story. 

As the nation’s only maker of nuclear-powered aircraft carriers, there’s a Huntington Ingalls label on most of the U.S. Navy’s fleet. And with the government’s fiscal 2023 budget earmarking $773 million for the Department of the Defense, the shipbuilder’s huge order backlog will only get bigger. 

After receiving $2 billion in orders in Q2, Huntington Ingalls’ total backlog swelled to $47.2 billion. That amounts to some serious cash flow coming to dock over the next few years. 

For such an immensely capital intensive business, Huntington Ingalls has a surprisingly sturdy balance sheet. The $3 billion in long-term debt is a non-issue because the company lacks short-term debt and has the cash flow to back it. 

Analysts project that earnings will grow around 14% and 17% in 2022 and 2023 respectively. Based on next year’s EPS estimate, the stock has a P/E ratio of just 14x. With a potential multiple expansion on the horizon, look for Huntington Ingalls to keep drifting higher.

What is Driving Growth at BJ’s Wholesale Club?

BJ’s Wholesale Club Holdings, Inc. (NYSE: BJ) is finally taking a breather after a steady ascent from its May 2022 low. The warehouse club operator exemplifies what mid-cap is all about — established companies that are still in an upward growth trajectory.

Essentially the mid-cap version of Costco, BJ’s Wholesale has all the markings of a long-term winner. The store count is being grown at a fast but responsible pace and investments in e-commerce are proving fruitful. There are now 229 clubs between Maine and Florida with an especially strong foothold in the New England region. 

At a time when American budgets are stretched, a new credit partnership with Capital One will afford customers flexibility. Aside from the attractive credit card and loyalty programs, lower-priced groceries and gas are the main draw here. More than 6.5 million members shop at BJ's and the renewal rate is a healthy 89%. Over the past 25 years, this has translated to an 8% annualized growth in membership fee income with four fee increases along the way.

As revenues and profits have grown over the years, BJ’s leverage ratio has come down substantially. In its most recent quarterly report, the net debt-to-EBITDA ratio was just under 1x — a stark contrast to the 5x multiple of five years prior. 

Now more nimble than ever before, BJ’s is looking to drive growth by adding new stores, launching convenient technology solutions and attracting more members — a playbook Costco and Sam’s Club have proven effective. Sometimes it pays to be the newer guy on the block.

Does F5 Have Good Fundamentals?

In the massive world of internet activity, F5, Inc. (NASDAQ: FFIV) is the traffic cop. Its software helps manage the flow of online communications and transactions by improving performance and keeping enterprises safe from cyberattacks. 

F5’s security solutions are in increasing demand as businesses migrate to the cloud. At the same time, subscription-based revenue is becoming a bigger part of the overall mix and an attractive attribute of the investment. 

With recurring revenue representing nearly three-fourths of total revenue, cash flow visibility is high, and the business model well-balanced among software, systems and services. The 42% international exposure is a headwind, however, and a big part of why the stock is down 40% since the start of the year.

In terms of the things it can control, management is doing a solid job. Alliances with tech heavyweights like Microsoft, Cisco, HP and Oracle are helping to strengthen the F5 brand and expand access to F5 products. The balance sheet is outstanding — no long-term debt and plenty of liquidity to meet near-term needs.

F5 reports fiscal Q4 results on October 25th. Forex, lingering supply chain issues and an IT spending slowdown will probably make for an uninspiring report. If the stock sells off on the news, it could present an opportunity to gain access to a financially fit SaaS business with exposure to long-term growth markets.