Stock of the Week

British Sky Broadcasting Group

Subscriber numbers up

Pay-tv broadcaster British Sky Broadcasting (LSE, BSY) is being overshadowed by issues affecting its major stockholder News Corp. However, results for the first nine months show profits up just under a quarter as the group overtook Virgin to become the UK's largest triple play provider.

The key to Sky is that it is a leader in content which allows it to out-bid others for additional content and thus attract more subscribers – a virtuous cycle. In March Formula 1 was broadcast on Sky for the first time while a deal to renew UK football premier League rights should be signed in the autumn.

The litmus test is subscriber numbers which drives investor sentiment and demonstrates the group's market appeal relative to competitors. The competition is Virgin Media which has the best broadband, Freeview has free digital content and internet only offerings provide low-cost subscription in niche areas like movies.

Looking at the subscriber numbers and Q3 (three months to the end of March) saw a stronger quarterly increase than a year ago at 78,000 extra customers and 904,000 extra total products sold. Thus while overall customer growth continued the key driver was selling more products which means higher product uptake with existing customers. Total product growth was 13% with total products per subscriber now 2.6 versus 2.4 a year ago.

Churn decreased to 10.1% from 10.4% a year ago with 31% of customers now taking triple play which is up from 26% a year ago. Average revenue per user was up by £9 to £546.

In fact Sky is now the largest triple play provider in the UK, having overtaken Virgin Media, with 3.2m triple play customers. This comes as home communications saw 702,000 additions which was the strongest ever quarter.

For the nine month's of Sky's financial year so far (to end March) revenue was up 5% which on face value doesn't look strong. However, it comes as operating margins are improving as the marginal cost of providing services to new or existing customers is low and the group continues to cut costs.

While direct costs – content and so forth – as a percentage of sales are increasing other operating costs are falling. As such operating margins are trending higher to 17.9% in 2012 against 15% in 2010.

Thus the 5% increase in revenue fed through to a 15% increase in operating profits for the nine months to the end of March. Share buy-backs helped translate this into an even larger increase in earnings per share with a 24% boost to 37.8p.

Buybacks completed so far come to £387m with £750m planned which is not insignificant relative to the £12bn market value of the group i.e. around 6% of the market cap. The dividend yield at around 3.5% shows that Sky has matured into a cash cow provided it can maintain its pre-eminent content position relative to competitors.

The yield for the next financial year (12 months to end June 2013) is just under 4% and the forecast P/E comes in at 12.9X. This doesn't look expensive but is dependent on Sky retaining traction with its subscribers.

This report was produced by Senior Research Analyst, Andrew Latto.

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