After a year to forget in 2014, which was more or less the case for UK equities in general, BT (LSE: BT-A) and Sky (LSE: SKY) shares have sprung back to post double-digit gains so far in 2015.
While those who have hung in there for the duration at either company will probably be glad to have done so, I write today with both existing and ‘still on the fence’ investors in mind.
This is because, after gains of almost 25% during the year to date for both sets of shares, the fortunes of investors at each company could now be about to diverge.
Most notably, BT’s efforts at diversification and expansion could continue to pay off over the medium term; however, this may come at the expense of Sky, Vodafone and TalkTalk shareholders.
Diversification…
Late October saw BT achieve the almost insurmountable. It received the provisional go-ahead from regulators for its proposed takeover of the UK’s largest mobile network, EE, which prompted an inevitable wave of condemnation from competitors and yet more lobbying for the divestment of OpenReach from BT.
While pay-tv is worth close to £10 billion to Sky annually and the combined mobile market significantly more to the industry incumbents, if successful then BT’s move deeper into mobile and pay-tv could now see it become a sector leader across the communications and entertainment space.
However, this will probably come at the expense of companies like Sky and Vodafone, who are now likely to suffer from margin compression as competition in their respective sectors heats up.
Valuations are still undemanding…
Perhaps the very last thing that ‘on the fence’ investors would expect after this year’s gains is for either of the shares to still trade at a level where valuations are undemanding. But this is still very much the case.
From a price to earnings perspective, BT shares currently trade at 15x the consensus estimate for earnings per share (EPS) in 2016 and 14x the estimate for EPS in 2017.
This implies a notable discount to the 21x average of the UK telecoms sector, and the 16x average for the European telecoms space as a whole.
Sky trades at 16.2x the consensus for EPS in the current year, which represents a discount to the average for UK telecoms and is broadly in line with the European average. However, lower estimates for subsequent periods mean that the current valuation rises automatically further down the line.
Dividend growth…
In addition to a reasonable valuation, the dividend outlook at BT also remains attractive. Current consensus estimates suggest that both earnings and the dividend will continue to grow in the low double digits for the foreseeable future, with dividend cover remaining above 2x the payout.
This level of cover compares well against the UK average of 1.4x and the 1.0x cover for BT’s European counterparts.
Such a surplus relative to peers also suggests to me that, even if growth were to stagnate, the outlook for cash returns to shareholders would remain bright for at least the foreseeable future.
However, the potential downward trajectory of earnings at Sky means that the outlook for dividend growth here is becoming less certain. While the consensus for the current period implies cover that is close to 2x, which is more than reasonable, declining earnings in future periods will mean that cover deteriorates even without dividend growth.
A Pavlovian response…
Regardless of how Pavlovian it sounds, buying on dips no longer seems like such a bad idea for existing and prospective shareholders at BT. However, I can’t help but feel that Sky shares could be about to indemnify the old adage of ‘buy low and sell high’.
With the above in mind, I’d probably be quite happy to contemplate the idea of buying BT for my own portfolio but if I were a Sky shareholder, I might be inclined to re-evaluate my position.
