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 companys shares have fallen out of favour with investors.
And theres good reason to believe that Talktalks shares could have further to fall from present levels. Indeed, even after falling by more than a fifth year-to-date, Talktalks shares still trade at a premium forward P/E of 21, which doesnt leave much room for error. Larger peerBTcurrently trades at a forward P/E of 16, which seems more sustainable.
Whats more,Talktalkis yet to revealwhat effect Octobers hack has had on the companys sales and customer numbers. Management has stated that the group is still on track to meet full-year forecasts, which seems highly optimistic. This isnt 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 its going to be an uphill struggle for Talktalks managementto rebuild customer trust. The consensus among City analysts is thatTalktalkwill report earnings per share of 51% for the full-year, which justifies the companys highvaluation, but it really is difficult to see howTalktalkwill meet these forecasts after all thats happened to the company this year.
The cyber-attack is only one of Talktalks problems.During the first half, the companys 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, its going to be difficult for Talktalk to win over more customers as larger peers such asSky (LSE: SKY) pump moneyin marketing, new content and price reductions.
Even though Sky andTalktalkareboth chasing the same customers and offer similar services, its clear that Sky is the better company, and deserves to trade at a premium to Talktalk.Skyis 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 overTalktalk, 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 Skys 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 a10% increase in operating profit to 375m.
So overall, amid the ongoing uncertainty surrounding Talktalks 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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