Budget 2021: the impact on dividend headroom

Investors cheering a ‘super deduction’ boost to BT were brought down to earth with a bump.

Investors cheering a ‘super deduction’ tax boost for BT Group (LSE:BT.A) shares were brought back to earth today with a warning about the Budget's longer-term impact on dividend headroom.

UBS analyst Polo Tang said plans to raise corporation tax to 25% by April 2023 will more than offset the near-term benefit of the chancellor's two-year tax break on capital investment.

BT shares were among the biggest risers in the FTSE 100 index yesterday, but Tang said the 7% rise to a near two-month high of 134.5p looked to be overdone as he reiterated his ‘sell’ recommendation and price target of 111p.

He warned that the Budget represented a £135 million a year hit to BT's free cash flow over the longer term, meaning less headroom for the dividend.

There's currently no payout at all after bosses last year axed theaward for the first time since privatisation in 1984 and also rebased future expectations. BT’s cash-generating qualities have made it appealing to income-seeking investors over the years, but this has been thwarted by the pandemic and the need to prioritise modernisation of its network.

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As this involves investment of £12 billion in a full-fibre broadband roll-out over the next decade, investors welcomed the potential tax relief on investment in plant and machinery.

Chancellor Rishi Sunak's super deduction of capital allowances will enable companies investing in new equipment to reduce their taxable profits by 130% of the cost of the investment. Tang notes BT's capital expenditure is £4 billion, although not all of this will qualify, and said the telecoms group currently paid about £445 million a year in taxes using a 19% tax rate.

He said: “On a best case, BT would pay no taxes for two years but thereafter taxes would rise to £580 million from 2024 onwards assuming a 25% tax rate.”

Tang noted other hurdles facing BT in the coming quarters included the imminent start of the UK's 5G spectrum auction and rising competition for its Openreach infrastructure division from footprint expansion by Virgin Media. A large pension deficit could also constrain both mergers and acquisitions and dividend prospects, he warned.

The first hike in corporation tax since the 1970s is expected to raise almost £50 billion for the Treasury over the next five years.

Liberum expressed surprise at scale of the increase, which it sees as having the potential to lower earnings in the UK corporate arena by 7% from 2024 and reduce future cash flows to shareholders by around 6%. Of particular interest will be the housebuilding sector as bosses have previously noted the link between lower corporation tax and higher dividends.

As the chancellor's super deduction aims to boost investment in plant and machinery, the scheme is likely to be beneficial for a number of stocks in Liberum's coverage, including Howden Joinery (LSE:HWDN), Safestyle (LSE:SFE) and Volution (LSE:FAN).