Investment: It's time to tune in to Sky's profit potential

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The Independent Online
IT'S BEEN a nervous few months for British Sky Broadcasting. But after undermining the only serious challenger to its position in pay television, the satellite broadcaster looks set to dominate digital television. If so, its shares are dramatically undervalued.

In digital television, Sky holds almost all the cards. When it launches at the beginning of October it will have all the best channels - many available at prices which are no more than those being promised by ONdigital, its terrestrial rival. What's more, Sky will have the advantage of being first off the mark.

True, profits will be slow in coming. After yesterday's 14 per cent drop in pre-tax profits to pounds 271m, earnings are likely to fall again in the current year.

But investors should ignore the short-term hit. Indeed, given that Sky is heavily subsidising the costs of buying and installing satellite dishes, profits should fall further the more successful it is in winning new customers.

What Sky is effectively doing is paying up front for a stable, long-term stream of revenues in the future. And provided it does not slip up, subscribers should remain customers for a long time.

How many subscribers will Sky have? A fair starting assumption is that it will, in time, convert the majority of its 4 million-odd existing subscribers to the digital service.

Add in some more who are attracted by wall-to-wall movies or blanket sports coverage, and a few who like the interactive services to be launched next year, and you have quickly arrived at the 6 million subscribers that Sky has forecast itself.

Getting there will take years. But once the first batch of subscriber figures comes through in January, investors are likely to start waking up to Sky's profit potential. The shares, up 10.5p to 428.5p yesterday, do no justice to the potential upside. Buy them.

Builders' net slows BICC fall

INVESTORS IN BICC could be forgiven for thinking that someone has cast a spell on the company. For more than a year the cable and engineering group has been lurching from crisis to crisis, through little fault of its own.

Despite the management's brave efforts to stem the tide, the company was caught in a hefty cyclical downturn in its main markets.

First to go was the European energy cable business, savaged by a fall in demand and the strength of the pound. BICC's management responded swiftly, slashing more than 2,000 jobs in an effort to cut costs and bring the business back on track.

But, just as BICC was looking forward to reaping the benefits of this painful medicine, the fibre-optic business took a tumble. In the past year prices for hi-tech cables have slumped more than 25 per cent as increased competition and lower demand from European telecoms companies pushed the market into overcapacity.

This collapse was behind yesterday's pounds 9m fall in interim pre-tax profits to pounds 46m. The earnings shortfall would have been greater had it not been for a scintillating performance from Balfour Beatty, BICC's construction and engineering subsidiary. The division's profits almost doubled to pounds 30m, boosted by major railway contracts in the UK and good growth internationally.

In spite of Balfour's good news, the outlook is bleak. Prices and margins in the cables business will remain subdued in the near term, as oversupply continues to dominate the fibre-optic market, while energy cables are not expected to recover until 1999.

Balfour's growth will also moderate as construction gets caught in the inevitable UK economic slowdown.

True, most of this doom and gloom is already in the price which, after yesterday's 0.5p rise to 112p, is on a measly 11 times 1998 earnings. But until there is a firm sign of an upturn in cables, the shares are no more than a hold.

War games can still march on

IS THE fantasy over at Games Workshop? The war games maker had been one of the great growth stocks of the past few years until May, when a profits warning shot the price down in flames.

The company blamed much of its shortfall on the strong pound, which wiped pounds 2.3m off the bottom line in the year to end-May. Without this, profits would have been up 23 per cent. In fact, they rose just 3.5 per cent to pounds 11.5m.

The real problems, however, were caused by poor stock management, exacerbated by the effects of consolidating the business on one site. Games Workshop also pushed through a misguided price hike which led to a 6 per cent drop in UK sales. The company says the former has been put right while the latter will not be repeated.

The company shows no sign of slowing the expansion programme which has been largely responsible for its growth to date. It plans a further 34 outlets this year, 28 of them outside the UK. It may have a point. Pocket money spending is relatively recession-proof and toy soldiers have a timeless appeal.

If constant exchange rates are assumed, profits in the current year are expected to rise to pounds 14.5m and earnings per share to 30.1p compared with 31.8p before the warning. The shares rose 12p to 462.5p, but they are still far below the peak of 857p when the warning was issued. On a forward multiple of 15 they are worth a look.

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