It ‘s hard to fault BT (LSE: BT.A) and SKY (LSE: SKY) on their performance over the past six years. Since the financial crisis, the two companies have charged ahead of the wider market.
Since the beginning of June 2009, BT’s shares have gained 380% (excluding dividends) while Sky’s shares have added 135% (also excluding dividends).
Over the same period, the FTSE 100 has only gained 56%.
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BT and Sky’s performance over the past few years can be traced back to their impressive growth rates.
For example, between the end of fiscal 2010 and fiscal 2015, BT’s net profit increased at a compound annual growth rate (CAGR) of 15.7%. Earnings per share also increased by a similar amount over the same period.
However, revenue has fallen by around 3.0% per annum since 2010. The reason why BT’s profit has increased while profit has slumped is simple. During the past six years, BT’s operating profit margin has increased by 78%, around 14.5% a year.
Product cross-selling and higher margins products, such as pay-tv as well as broadband services, have been the key drivers behind this growth.
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Sky has achieved similar growth rates to BT during the past six years.
Between the end of fiscal 2009 and fiscal 2014, Sky’s revenue increased at a CAGR of 7.3%. Net profit rose at a CAGR of 27.3%, and free cash flow per share has doubled over that period.
What’s more, according to figures from City analysts, by the end of this year Sky’s shareholder equity — which is in some respects the underlying value of a company — will have quadrupled since 2010.
What does the future hold?
The big question is: will Sky and BT be able to maintain these lofty growth rates or are their days of growth behind them?
The City seems to be split when it comes to answering this question. On one hand, Sky’s sales are coming under pressure from the likes of online streaming services such as Netflix. Meanwhile, BT is trying to fight off competition in the telecommunications sector from smaller upstarts like Talktalk.
On the other hand, Sky’s recent acquisition of its European peers has given the group an unrivaled position in Europe’s pay-tv market. Similarly, BT continues to dominate the UK telecoms market.
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Unfortunately, for Sky at least, the company’s business model is beginning to show signs of stress.
Specifically, the company’s return on capital employed (ROCE), a key metric for measuring profitability compared to assets, is set to fall to 10.1% this year. In the past, Sky’s ROCE has averaged 30%.
A high double-digit ROCE often means that the company has a defensible edge versus its competitors. As Sky’s ROCE is falling, it’s reasonable to assume that the company’s edge over peers is falling away.
BT’s ROCE has increased by 50%, to 16.3% since 2010, but the company is facing other pressures.
These include issues with the competition commission, a brutal pay-tv price war with Sky, a ballooning pension deficit and sliding earnings at the company’s legacy fixed-line business.
Overall, with competition increasing, BT and Sky’s growth may slow from a high double-digit to mid-single-digit rate over the next few years.
