After the recent equity rally, many cyclical stocks look vulnerable. So it’s time to rotate into more defensive shares such as BSkyB, the UK’s leading pay TV broadcaster.
Last week it reported some gravity-defying results in the face of perhaps the worst recession for two generations. While families are cutting back on shopping and dining out, it seems they are spending more time and money on watching television.
For the three months ending March, Sky’s average revenue per user rose 6.6% to £452, the cancellation rate held steady at 10.6%, and the number of Sky+ and high-definition (HD) viewers rocketed to one million and five million respectively. In total the group has 9.3 million customers, 15% of whom take TV, broadband and telephony, compared with just 9% a year ago.
Those great numbers are only one part of BSkyB’s appeal. It also has the funds to buy prized content, such as the rights to Premiership Football, just as many of its rivals are short of cash. Setanta, for example, has short-term funding issues, Virgin Media is saddled with hefty debts, and BT carries an onerous pension deficit.
BSkyB (LSE:BSY), rated OUTPERFORM by Sanford Bernstein
Sky is not short of growth opportunities either. The group is ramping up its video-on-demand and 3D services. This is clever as both can be broadcast via existing HD infrastructure. And England qualifying for next summer’s World Cup finals would provide a massive boost.
The City is forecasting sales of £5.2bn and £5.5bn for the next two years, generating earnings per share (EPS) of 27.5p and 32.2p. The shares trade on respective p/e multiples of 17.8 and 15.2. These don’t look too high given the firm’s £1bn – 55p per share – of annual operating cash flow and its secure 17p dividend. And with most of its costs fixed, any future increase in turnover should be reflected directly in higher profits.
So, what are the risks? Unemployment is rising and advertising revenues are under pressure, so economic conditions look set to remain tough for a firm that generates significant revenue from its lowest income customers. The closure of 40 pubs each week and falling hotel bookings could put pressure on corporate sales. A loss-making broadband unit also needs to be sorted out. But if prices start to firm up, margins may improve. Finally, the firm could still hit trouble with regulator Ofcom over its 17.9% stake in ITV, bought for £940m in November 2006.
That said, with demand rising and costs falling, Sky looks a safe bet for the long-term investor. Given its attractive recurring revenues, huge barriers to entry and infrastructure backing, I estimate the business is worth 12 times earnings before interest, tax, depreciation and amortisation (EBITDA). After allowing for £1.7bn of debt, that equates to about 630p per share.
Recommendation: long-term BUY at 490p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments