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Underrated Inmarsat set to rocket

CONTRARIAN TIP OF THE YEAR: Problems at peers have knocked the satellite group's shares, leaving them primed for a re-rating
Underrated Inmarsat set to rocket

We think the market has overblown the severity of recent problems at satellite giant Inmarsat (ISAT) and the shares substantial re-rating potential make them an excellent contrarian play for 2017. Launch delays, a profit warning from a peer and patches of weak trading have sent the shares spiralling to their lowest level in years. But recent contract wins, improving end markets and surging long-term demand for wireless connectivity suggest the sell-off has been overdone.

IC TIP: Buy at 734p
Tip style
Growth
Risk rating
High
Timescale
Long Term
Bull points
  • Exposed to surging data demand
  • Shares trade close to a four-year low
  • Large and growing yield
  • Blue-chip customers and contract wins
Bear points
  • Marine and enterprise weakness
  • Negative market sentiment

Inmarsat's satellites beam wireless internet to customers on land, at sea and in the air. Management expects Global Xpress (GX) - its worldwide, high-speed broadband network, which entered commercial service in late 2015 - to generate $500m (£405m) in annual turnover by the end of 2020, not including any contribution from a fourth GX satellite, now scheduled to launch in 2017 following problems at partner SpaceX. The delay means Inmarsat now expects spending of $500m to $600m in 2017, but that looks manageable given its recent raising of $1.05bn of long-term capital.

The group's latest results show bright spots emerging across its divisions. Aviation sales rose a tenth in the nine months to 30 September, as SwiftBroadband grew its installed base to around 7,900 aircraft. True, lower usage in some markets and higher business development costs meant cash profits fell 9 per cent. But management signed up Lufthansa and Air New Zealand to GX for its Aviation in-flight broadband service. And IAG plans to install Inmarsat's forthcoming European Aviation Network (EAN) - a high-speed, in-flight passenger broadband service - on up to 341 planes across British Airways, Iberia and other airlines.

 

 

Government revenues also grew, driving the division's cash profits up 13 per cent, after both fell around a tenth in the same period of 2015. Its gains reflected strong demand for GX services, new products such as airborne surveillance and more international activity, which helped to offset economic and budgetary pressures. However, sales slid 8 per cent and cash profits flatlined in the enterprise division, as oil and gas customers opted for cheaper plans and cut back on usage, but the resurgence in commodity prices could now prove a tailwind.

Both sales and cash profits dipped in the maritime division, which generated about 45 per cent of Inmarsat's turnover and 59 per cent of its cash profits in the nine months. That reflected depressed shipping and energy markets, as well as management upselling customers to newer products that should ultimately provide a firmer foundation for future growth. More positively, resellers will install Fleet Xpress on more than 5,000 vessels over the next five years. And Ligado, a formerly bankrupt partner, contributed $89m in revenue and could pay up to $136m a year to Inmarsat if regulators approve its network plans.

Recent deals should underpin further momentum, too. Inmarsat has appointed Honeywell as an aviation distribution partner and Boeing as a GX reseller to the US government, penned an 'internet of things' roaming deal with Vodafone, partnered with Ericsson to develop connected ship solutions and won work with the US Navy.

Management also points to growing awareness among shipping and energy customers of the potential for greater connectivity to reduce costs, increase efficiency and boost competitiveness. Indeed, Jefferies analysts expect maritime sales to increase by 9 per cent in 2017 due to subscriber growth, higher average revenues from upselling and price increases, and improved sentiment in the shipping market. The broker also expects leverage to peak at a manageable 2.75 times cash profits and fall to 2.3 times by the close of 2019. That's comfortably below the company's target of less than 3.5 times, providing some reassurance about the thinly covered dividend, which is not expected to be covered by cash flow again until 2019.

Inmarsat's downtrodden shares trade on 15 times forecast earnings for 2017 - an unwarranted discount to peers such as Intelsat and SES - and the prospective yield of 6.2 per cent is attractive. Jefferies argues that the current valuation implies only $200m in annualised revenue growth, when existing contracts exceed that amount. They regard the current valuation as assuming the fourth GX satellite is shelved, the EAN fails, Ligado's lease payments shrink by 60 per cent and management halves GX revenue guidance - an improbable string of developments.

INMARSAT (ISAT)
ORD PRICE:742pMARKET VALUE:£3.4bn
TOUCH:741.5-742p12M HIGH / LOW:1,153p664p
FORWARD DIVIDEND YIELD:6.2%FORWARD PE RATIO:15
NET ASSET VALUE:282¢*NET DEBT:141%

Year to 31 DecTurnover ($bn)Pre-tax profit ($m)**Earnings per share (¢)**Dividend per share (¢)
20131.2618922.846.6
20141.2934276.048.9
20151.2733863.051.0
2016**1.3132957.954.0
2017**1.4535162.656.7
% change+10+7+8+5

Normal market size: 2,000

Matched bargain trading

Beta: 0.57

£1=$1.24 *Includes intangible assets of $776m, or 172¢ a share

**Jefferies forecasts, adjusted PTP and EPS figures