Utilities have come under pressure this year following commitments from both major UK political parties to cap energy prices, but there is a gem within the sector which is still worth backing, according to Kames Capital.
Iain Wells, manager of the Kames Capital UK Equity Income fund – one of the top performers in the IA UK Equity Income sector – says that while utilities are being buffeted by political and regulatory headwinds, he has recently added to power generator SSE following a slide in the share price since the turn of the year.
“The utilities sector enjoyed a period of declining interest rates during which companies issued debt at ever cheaper levels, and their pricing was better than expected,” he says. “But now they are struggling as rates rise and as the regulatory cycle gets underway. However, SSE’s situation is different. The price is already broadly discounting some of this uncertainty, and the dividend – which is currently forecast at 6.3% – is very attractive.”
While Wells and co-manager Douglas Scott have added to SSE, Wells says the remainder of the sector still looks challenged, in particular the UK’s water companies.
“Water looks like a much tougher environment now, with the industry regulator Ofwat recently warning that companies it monitors will find the going a bit harder now,” he says. “In general for utilities, the future won’t be anything like the past, and it is an area to be wary of.”
Looking more broadly across the equity market, Wells says valuations remain generally attractive given the dividends paid by many UK companies. However, he says any correction for some of the smaller companies in the UK could lead to a wave of M&A.
“There is still some value there with regards to companies in the FTSE 100, while the FTSE 250 has also been strong and many companies are on high multiples,” he says. “However, if there was a material correction in the FTSE 250, we would expect there to be quite a lot of interest from predators looking at UK names.”
The Kames UK Equity Income fund currently has around 20% of its assets in the mid-cap space, with the majority in the large cap universe. Over the last three years, the fund has delivered a 33.49% return versus the IA UK Equity Income sector average of 24.88%
 According to Google Finance, SSE’s share price has declined 10.57% YTD, between 03/01/17 and 27/07/17
 According to the 30 June factsheet, the fund had 21.9% in mid caps, with 74.5% in large caps.
 Source: Lipper. ‘B’ Share Class – NAV to NAV, noon prices, income reinvested, net of ongoing charges, excluding entry or exit charges, net of 20% income tax in periods before 31/07/2017.