BT downgraded but Next support continues

A “sell” stance on BT Group (LSE:BT.A) and improved target price on Next (LSE:NXT) today highlighted this year’s contrasting fortunes for two widely held members of the FTSE 100 index.

UBS’ deep dive on BT prospects caused the shares to fall more than 4p to 105.6p, leaving the telecoms firm close to the bottom end of the 100p-200p range of the past five years.

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Despite Next trading at a record high following last month’s annual results, the same investment bank sees room for the retailer’s shares to consolidate gains through a further rise to 9,400p.

The motivation for the upgrade is greater visibility on the profit contribution and growth opportunity of the company’s Total Platform (TP) of retail software and infrastructure.

Last year’s addition of JoJo Maman Bébé, Joules and MADE took the number of clients on the platform to seven, with FatFace due to be added in the autumn of this year.

Next expects the Total Platform along with its associated equity investments to contribute £77 million or 8% of group profit in the year ahead, compared with nothing three years ago.

The platform allows Next “to capture the value of what other acquirers would call synergies”. It does so as a profit stream to Next, with cost savings and service benefits for subsidiary clients.

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UBS said recent guidance by Next had helped it build the earnings profile of the TP businesses, which are likely to be faster growing than the more mature Next brand. 

It has made modest increases to its overall profit forecasts for this year and next but with its mid-term and longer-term forecasts progressively higher.

The bank said the re-rating of shares to 15.3 times earnings took the valuation well above the pre-Covid average of 12 times and fully reflected the Total Platform potential. Its new price target and Neutral recommendation compares with 7,250p previously.

On BT, the bank’s “anti-consensus” sell stance and 10p cut in target to 100p reflects fears that things will get worse before they get better in a story of many moving parts.

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It thinks that new chief executive Allison Kirkby could use fourth-quarter results on 16 May to accelerate the existing strategy, a move that would put further pressure on cash flow and the dividend through higher capital expenditure and further restructuring.

The dividend was last cut in the 2020 financial year when BT suspended it for 18 months so that it could step up its full-fibre rollout and deal with the uncertainty of the pandemic. 

It was reinstated from 2022 at half the prior level at 7.7p, representing a current payment of £759 million a year.

However, UBS estimates that free cash flow after taking into account costs from the TNT Sports joint venture and restructuring is £629 million and will fall below £300 million in the medium term.

In addition, the bank thinks broadband infrastructure competition is re-accelerating with Openreach broadband line losses likely to remain elevated for longer.

On a brighter note, UBS believes the risk of TalkTalk being acquired by Virgin Mobile O2 appears less likely in the near-term. TalkTalk spends over £850 million a year with Openreach and it would have represented a major client loss.

Sky is exclusively with Openreach but UBS said it would not rule out the longer-term diversification of some or all of its £950 million-a-year business.