Our companies analyst assesses the strengths of this industry from a personal perspective, and concludes it’s a good bet in a troubled world.
Telecoms were an interesting standout versus Monday’s market slide, with BT (LSE:BT.A) up 3p to 192p until Wall Street took a big dive, and Vodafone (LSE:VOD) up 7p to 125p, significantly on merger speculation in Sunday’s press.
Both stocks have been in a strong bull trend since early November, up 38% and 15%, respectively. To what extent might this reflect a general shift towards ‘defensive’ stocks with assumed yield strength? How resilient are they to inflation, and also to market turbulence now the Ukraine crisis looks set to fester?
Markets finally wake up to Putin’s brinkmanship
Following my piece on East European hostilities last Friday, there is no genuine diplomacy under way and both sides’ positions are hardening: Russia seeks a return to the 1990s balance of power in Eastern Europe, while Nato’s red line is to maintain – indeed reinforce – its defences in Bulgaria and Romania.
- Stockwatch: what could Ukraine invasion mean for investors?
- Our outlook for 2022: key topics and investment ideas for the year ahead
Possibly, a way out of conflict over Ukraine would be to declare autonomy in the Donbas eastern region of the country; but hawks in the West would dismiss that as classic appeasement, rewarding Putin’s tactics and raising the odds that they will continue.
The prospect of war and sanctions likely to harm the West as well as Russia are coming just when central banks need to tighten monetary policy to contain inflation. A flight to safety is justifiably under way in equities, but do telecoms constitute more than a current wonder?
Companies genuinely able to pass on price rises
My bullishness on telecoms derives initially from scepticism about Ofcom – which I do not regard as sufficiently strong in consumer interests. Price rises will not be challenged by a regulator that has swallowed the corporate line – that they are justified by necessary investment to upgrade infrastructure.
BT’s managing director for consumer customer services tweeted five days ago about a 9.3% total price rise from 31 March – constituting CPI inflation of 5.4% plus BT’s policy of 3.9%. As far as I can see across the industry (having just lately searched for a relative wanting to switch provider), rivals are broadly herding around this rate of increase; I would say they are taking their cue from what the big beast in British telecoms has got away with on pricing policy.
Ofcom will doubtless not object to BT’s citing an exceptional factor: the “dramatic increase” in data usage over recent years. Broadband use has risen 90% since 2018 and mobile data usage is up by 79%. BT’s relentless spamming of customers to take up BT Sport subscriptions over recent years is unrelated.
- Insider: two buying opportunities after shares sell-off
- Watch our share tips here and subscribe to the ii YouTube channel for free
Another reason (within its marketing agenda) is “unlimited” use plans requiring network investment to handle the big increase in demand. Simultaneously, the pandemic has boosted working from home, online education and TV streaming.
Ofcom has already allowed BT to write “3.9% plus inflation” into its terms and conditions, so it will be interesting to see if in due course rivals use this benchmark to price more keenly. But for the time being, Vodafone and others are in line.
Aside from merger speculation with Three, which would potentially re-rate Vodafone’s UK reach, the extent of price rises looked a key reason for BT shares’ strength Monday morning, as investors digested over the weekend how those price rises could reinforce cash flow and thereby payout prospects.
BT offers relatively more secure dividend profile
A key reason why I drew attention to BT as a “buy” from 102p in November 2020 was its firm objective to restore a 7.7p progressive dividend policy. It presented a chance to lock in a circa 7.5% yield, with the stock also set to benefit both from investor demand and as the dividend de-risks. We now see a confident approach to consumer price rises as partly reinforcing this.
Comparison of financial summary tables also shows BT with a relatively more robust profile than Vodafone, despite criticism of a lengthy restructuring that led to a change of CEO. Both groups show revenue and profit declines broadly since 2018, yet BT sustained earnings cover for its dividend of 1.2x to 2.0x and, according to forecasts, should enjoy around 2.5x in respect of 2022 and 2023.
- Stockwatch: exciting times for these two shares
- Where to invest in Q1 2022? Four experts have their say
Vodafone, however, has seen much tighter earnings cover – albeit robust cash flow – with consensus for 1.1x and 1.2x going forward. Yes, dividends are paid out of cash flow, but the stock market is going to question the disparity with earnings. This, in a nutshell, is why Vodafone is priced for a 6.2% prospective yield at 124p currently, versus 4.2% for BT at 190p.
Both companies have substantial liabilities: Vodafone is geared at around 100% net and BT at 155% net, while in terms of overall risk of serious financial distress within the next two years, Vodafone edges into a “distress” rating on the Altman Z2 score, compared with BT at the upper end of “cautious”.
To Vodafone holders, I would say these credit ratings do tend to be historical in perspective and the market is right to sense potentially greater strength from merger prospects going forward. Quite whether that adds up to a “buy” case is unclear; it would be speculative, for sure.
BT Group - financial summary
Year end 31 Mar
|Revenue (£ million)||18,879||24,082||23,746||23,459||22,824||21,370|
|Operating margin (%)||17.9||12.3||13.3||14.0||13.8||12.0|
|Operating profit (£m)||3,384||2,957||3,163||3,282||3,143||2,569|
|Net profit (£m)||2,466||1,908||2,032||2,159||1,734||1,472|
|Reported EPS (p)||28.3||19.1||20.4||21.6||17.4||14.6|
|Normalised EPS (p)||35.3||33.1||29.6||28.4||21.3||20.5|
|Operating cashflow/share (p)||59.1||61.8||49.5||42.7||62.9||59.2|
|Capital expenditure/share (p)||28.0||31.5||33.8||36.9||41.2||48.7|
|Free cashflow/share (p)||31.1||30.3||15.7||5.8||21.7||10.5|
|Earnings cover (x)||2.0||1.2||1.3||1.4||3.8||0.0|
|Return on equity (%)||45.2||20.7||22.3||21.5||13.9||11.1|
|Net debt (£m)||10,847||10,665||10,725||11,996||19,253||18,185|
|Net asset value (£m)||10,112||8,335||9,911||10,167||14,763||11,679|
|Net asset value/share (p)||102||84||100||102||149||118|
Source: historic company REFS and company accounts
Vodafone - financial summary
Year end 31 Mar
|Revenue (€ million)||49,810||47,631||46,571||43,666||44,974||43,809|
|Operating margin (%)||2.7||7.8||9.2||-2.2||9.1||11.6|
|Operating profit (€m)||1,320||3,725||4,299||-951||4,099||112|
|Net profit (€m)||-5,405||-6,297||2,439||-8,020||-920||112|
|Reported EPS (euro cents)||-20.3||-7.8||15.8||-16.2||-3.1||0.4|
|Normalised EPS (cents)||-18.0||-9.8||16.3||-6.7||-7.9||1.2|
|Ops cashflow/share (cents)||53.7||50.8||48.8||47.0||59.1||58.0|
|Free cashflow/share (cents)||1.7||19.2||19.5||17.5||33.2||28.9|
|Earnings cover (x)||-1.4||-0.5||1.1||-1.8||-0.4||0.0|
|Return on capital (%)||1.0||3.3||4.0||-0.8||3.0||4.0|
|Net debt (€m)||38,793||31,314||29,512||26,306||54,279||52,780|
|Net asset value (€m)||83,325||72,200||67,640||62,218||61,410||55,804|
|Net asset value/share (cents)||314||271||254||228||229||198|
Source: historic company REFS and company accounts
Lengthening service contracts mitigate balance sheet risk
I recall, as a BT customer, that some years ago contract length rose from 12 to 18 months; and just recently I was pitched with a renewal offer it would seemingly be foolish to decline, to enter a 24-month contract for broadband.
The pricing was very keen, although it amounted to somewhat false reassurance as BT’s terms and conditions allow for change. I believe even the “3.9% plus inflation” is not set in stone.
Tying customers into longer-term contracts builds earnings quality and reduces dividend risk, despite appearing less competitive. If the telecoms industry was genuinely competitive, then 12-month contracts would operate as they do in insurance.
- Six value share tips for 2022 – and beyond
- Friends & Family: ii customers can give up to 5 people a free subscription to ii, for just £5 a month extra. Learn more
Doubtless Ofcom accepts an industry view of how it promotes investment, rather than enabling consumers to switch (without penalties) on an annual basis, thereby limiting price rises.
Vodafone similarly now declares 24-month contracts. I find myself unlikely to switch from BT, given its mobile SIM card offer appears keenly priced, and with double data as a broadband customer and access to various BT hotspots. Owning EE helps the transition to 5G services. Despite post-Brexit criticism about likely raised charges, I recently got through to a friend – as a free call, on an “unlimited” SIM package – on the Continent. Free Norton protection for my devices is another plus.
There must be millions of other BT customers like me who are likely to acquiesce in such an arrangement and are comfortable at entering a 24-month contract. BT will probably continue to sneak in price rises but is Ofcom going to act – or indeed will I, to change provider in two years’ time?
Convergence of policy terms and pricing has an ‘oligopoly’ feel
Unless Vodafone acquires Three to re-rate its UK presence, I view BT as having an increasing grip on UK telecoms that will help it steadily to de-risk its balance sheet besides investing in capability.
Both stocks’ momentum looks likely to consolidate, similarly to the way tobacco is benefiting from portfolio re-allocation into “defensive” sectors. On a three-month view, you might get better buying prices than today, if things go from bad to worse over Eastern Europe. Yet they constitute a firm “hold” through political uncertainty, able to pass on inflation and other costs without regulatory check.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.