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Kames’ Wells: Five outstanding UK domestic stocks for income

22 August 2017

Iain Wells, co-manager of the Kames UK Equity Income fund, highlights five companies with greater exposure to the domestic economy and compelling yields.

By Rob Langston,

News editor, FE Trustnet

Since last year’s EU referendum there has been increased hesitancy by some investors to invest in stocks that have a significant exposure to the UK economy but Kames’ Iain Wells (pictured) is finding a number of income opportunities in this area.

The Brexit vote to leave the EU has posed questions over the future relationship with the trading bloc and the potential impact on the UK economy. As such, investors have increasingly become more bearish about the prospects for the UK economy.

However, Iain Wells, co-manager of the £54m five FE Crown-rated Kames UK Equity Income fund, said while he recognises the challenges for UK domestic-facing stocks there are some interesting opportunities.

He said: “Like the wider market we have been wary on domestics because of challenges facing discretionary spend. But there are a number of exceptions.”

Since the EU referendum, Kames UK Equity Income has generated a total return of 22.89 per cent, slightly ahead of the IA UK Equity Income sector average return of 22.15 per cent, according to FE Analytics.

Performance of fund vs sector since referendum

Source: FE Analytics

The fund has a respectable yield of 4.2 per cent and, with a mandate to achieve an income in excess of the typical income returned from UK equity markets, Wells has highlighted five stocks generating attractive payouts below.

 

Card Factory

The first stock highlighted by the manager is Card Factory, a greeting cards retailer with 895 stores across the UK.

“Card Factory is highly cash generative and is the market leader in the UK greetings card market,” said Wells.

“Vertically integrated operations enables it to offer quality products at prices its competitors cannot match, while still generating attractive margins.”

“Further, market share gains seem likely with one of the other large players thought to be considering store closures in an attempt to improve profitability.”

In its most recent trading update for the six months to 31 July, the firm announced like-for-like sales growth of 3.1 per cent compared with the first half of 2016.

It noted: “Despite headwinds from foreign exchange movements and national living wage, the group remains highly cash generative, driven by its strong operating margins, limited working capital absorption and relatively low capital expenditure requirements.”


The FTSE 250-listed company has risen by 7.09 per cent since the EU referendum having fallen immediately after the vote, clawing back some performance in 2017.

Wells said: “As a small ticket item it is a relatively resilient category, an attractive characteristic when consumer incomes are under pressure.

“Management are not neglecting to invest in the business or grow the store estate, but they are willing to return surplus cash. Including special dividends a holder of Card Factory can expect a yield of around 7.5 per cent.”

 

Restaurant Group

A recent addition to the fund is Restaurant Group – which is also held by FE Alpha Manager Alex Savvides of JO Hambro Capital Management – the operator of brands such as Frankie & Benny’s and Chiquito.

“The business has had its challenges: uncompetitive prices, poorly thought out menu changes and a failure to market the brands effectively saw customers stay away,” said Wells.

“The result was sharply declining forecasts which mirrored the fall in the share price, down over 50 per cent from the highs of late 2015.

“Management has changed and are addressing the self-inflicted damage, with evidence that trading is beginning to stabilise. Any further evidence of improvement will be taken well.”

In its most recent trading statement in May, the group noted that total sales had declined by 1.5 per cent, noting that 2017 was a “transitional year” for the firm as it focuses on the competitiveness of its leisure businesses.

Since the EU referendum result, the group has returned 16.52 per cent, according to FE Analytics, as the below chart shows.

Performance of Restaurant Group since EU referendum

Source: FE Analytics

The manager added: “The consumer backdrop is definitely tough but cash flow is good, the business almost debt free and the dividend yield of 5.2 per cent looks secure.”

 

Kier Group

Another income pick is Kier Group, which Wells uses as a play on the UK infrastructure services, construction and property sector.

He said: “Contractors and support service companies have been a bit of a minefield for investors and often a source of unpleasant surprises.


“However, Kier’s focus on areas like mixed tenure housing and highway maintenance are comparatively low risk and in tune with the current political climate.”

In its pre-close trading statement for the year ending 30 June 2017, the firm noted that full-year underlying profit forecast was to be in line with expectations and had cut net debt to around £150m, at the lower end of market expectations.

Wells said: “The forecast 5.7 per cent dividend yield, which is forecast to grow 5-6 per cent per annum, is attractive.”

 

Forterra

Another stock with exposure to the construction industry is Forterra, the second largest UK brickmaker with a 30 per cent share of the market.

He said: “With three players controlling over 90 per cent of the market, limited capacity growth, good end demand and a shortage of houses, it is a good time to be a brickmaker.”

Indeed, the firm recorded a double-digit year-on-year increase in brick and block revenue during the first half of the year “reflecting good demand from the new build residential market”.

Wells added: “Historically this has been a cyclical industry which may limit the valuation multiple to around current levels of 12x earnings.

“However, cash generation is strong and debt is forecast to fall rapidly, allowing dividend to grow comfortably at 10 per cent per annum.”

 

Greene King

Finally, Wells has backed Suffolk-based pub retailer and brewer Greene King despite many of the challenges facing the industry more recently.

“It is tough times for pub and restaurant operator Greene King operator of over 3,000 pubs and restaurants across the UK,” the income manager said.

Performance of Greene King since EU referendum

Source: FE Analytics

“The headwinds are coming from weaker consumer spending, and cost increases driven by weaker sterling.

“The company has plans to mitigate these pressures although profit growth for the next couple of years will still be modest.”

However, Wells said that a more pessimistic outlook for the industry may have already been priced in.

“At 9x P/E [price/earnings] one can argue that the outlook is already captured in the share price,” he said. “For income investors the compensation is the 5 per cent prospective yield and the company’s long history of paying a progressive dividend.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.