BT (LSE: BT-A) and SKY (LSE: SKY) are two of the market’s most defensive stocks.
The two companies provide multimedia services to customers, which are usually sold on contracts that last for a year, or more. And with the customer paying a regular monthly fee for BT and Sky’s services, the two multimedia providers have a regular recurring income.
Moreover, as customers sign contracts for an extended period, BT and Sky’s revenues are, to a certain extent, immune from economic trends.
Cash machines
With a recurring income from customers, Sky’s cash generation is almost unrivalled.
During the past five years, Sky has generated £8.5bn in cash from operations, and the company invest a huge amount to generate such lofty returns. The company’s capital spending only amounted to £2.6bn over the same period.
As a result, last year Sky generated 100p per share in free cash flow, which means that currently Sky’s shares trade at a free cash flow yield of around 10%. Free cash flow yield offers investors a better measure of a company’s fundamental performance than the widely used P/E ratio. A ratio of 10% is highly attractive.
Moreover, Sky has been able to achieve staggering returns for investors over the past five years. Group return on equity (profit earned in comparison to total shareholder equity) was 64% last year and has averaged around 80% since 2010. Shareholder equity has increased at a compound annual rate of 41% since 2010 while book value per share over the period has risen from 32p to 184p, as reported at the end of last year.
Since 2009, Sky’s shares have outperformed the FTSE 100 by more than 100%.
These returns should continue for the foreseeable future. Sky has recently reported its highest ever level of organic customer growth, and the recent acquisition of European peers should help the enlarged group improve margins thanks to economies of scale.
Sky’s shares currently support a dividend yield of 3.5%, and earnings are forecast to expand 15% this year.
Working for shareholders
Sky’s cash generation is almost unrivalled. Indeed, unlike Sky, BT is currently forking out around £2.5bn a year to maintain its fixed telecoms network. As a result, BT’s current free cash flow yield is only 7%.
Still, BT’s management has shown over the past five years that it is working to create value for shareholders. Since the end of 2011, BT’s earnings per share have almost doubled, while revenue has declined by more than 10%. BT has been cutting costs and moving into more lucrative markets to boost margins, cash flow and grow shareholder equity.
As BT’s earnings have expanded, the company’s shares have charged higher. Over the past five years, including dividends, BT’s shares have returned 29.5% per annum — five times more than the FTSE 100 over the same period. As BT’s expansion powers ahead, these gains should continue.
BT’s shares currently support a dividend yield of 3.3% and trades at a forward P/E of 14.
