Are Sky plc And Talktalk Telecom Group PLC Overvalued?

Talktalk Telecom (LSE: TALK) used to be a market darling, but after announcing that it had been the target of a sustained cyber-attack last month, the company’s shares have fallen out of favour with investors. 

And there’s good reason to believe that Talktalk’s shares could have further to fall from present levels. Indeed, even after falling by more than a fifth year-to-date, Talktalk’s shares still trade at a premium forward P/E of 21, which doesn’t leave much room for error. Larger peer BT currently trades at a forward P/E of 16, which seems more sustainable. 

What’s more, Talktalk is yet to reveal what effect October’s hack has had on the company’s sales and customer numbers. Management has stated that the group is still on track to meet full-year forecasts, which seems highly optimistic. This isn’t the first time that the company has been the target of hackers, neither is it the first time that the company has lost customer data and it’s going to be an uphill struggle for Talktalk’s management to rebuild customer trust. The consensus among City analysts is that Talktalk will report earnings per share of 51% for the full-year, which justifies the company’s high valuation, but it really is difficult to see how Talktalk will meet these forecasts after all that’s happened to the company this year. 

The cyber-attack is only one of Talktalk’s problems. During the first half, the company’s retail broadband base shrank and its total on-net user base stagnated. Also, gross margins have been falling for the past two years, and the UK broadband market is becoming more competitive every day. With a poor reputation, it’s going to be difficult for Talktalk to win over more customers as larger peers such as Sky (LSE: SKY) pump money in marketing, new content and price reductions. 

Even though Sky and Talktalk are both chasing the same customers and offer similar services, it’s clear that Sky is the better company, and deserves to trade at a premium to Talktalk. Sky is internationally diversified, has a strong brand, loyal customer base and a unique product in the Sky service. Moreover, the company has pricing power, if it wants to hike the price for its sports package, many customers will continue to fork out for the service. Nonetheless, despite these fundamental advantages over Talktalk, Sky trades at a discount to its smaller peer. Specifically, Sky currently trades at a forward P/E of 17.8 and City analysts have pencilled in earnings per share growth of 13% for this year, a realistic target as Sky’s user base is still growing. For the three months ended 30 September the group reported 134,000 new customer additions across its European empire, a 6%year-on-year increase in group revenue to £2.8bn and a 10% increase in operating profit to £375m. 

So overall, amid the ongoing uncertainty surrounding Talktalk’s outlook, the company looks overvalued compared to Sky. On the other hand, Sky is pushing ahead and looks fairly valued at present. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Sky. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.