Interactive Investor

Stockwatch: has the investment case for BT improved?

20th August 2021 10:09

Edmond Jackson from interactive investor

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Our stocks writer takes a close look at the telecoms giant and asks whether its huge market share can be translated into higher earnings.

Since a mixed update in respect of BT Group’s first fiscal quarter to the end of June, the stock has appeared to maintain a downtrend from 205p in mid-June.

It was 184p on 28 July the day before the news, but slid to 172p in its aftermath and is currently 171p.  

Does this volatility have any relevance? “Efficient markets” theory would say the update was net negative, but I think the stock drop was less to do with fundamentals than sentiment having become a tad euphoric.

BT doubled in just seven months, an extent of rally that took even me by surprise after rating it a “buy” at 102p after last November’s interims.  

It would appear enough newcomers did not appreciate come 29 July how BT’s operations narrative tends characteristically to be mixed.

An international engineering technology giant like this is unlikely ever to be firing all cylinders; it is not Amazon (NASDAQ:AMZN) or Microsoft (NASDAQ:MSFT) benefiting from a big shift to cloud computing, but nor is its stock priced expensively like the US giants. 

Crucially, there was no counter to guidance  

A key plank of my investment rationale was the board declaring intent to pay out a 7.7p a share dividend in respect of the current financial year to March 2022. With progressive dividend growth thereafter, it implied a base-level yield of 7.5% - probably too rich for the attendant risks – hence the stock would mean-revert upwards. 

It is therefore a relief how agreement has recently been reached with the Communication Workers Union on modernisation essential to streamline the group and achieve efficiencies.

On 8 July, the two sides agreed an unspecified pay increase in 2022, also closure of buildings only where staff can relocate to an alternative location. Compulsory redundancies are to be avoided where possible.    

Frankly, I had been surprised at last November’s cavalier stance to declare such a pay-out – at a sensitive time for achieving consensus with the workforce. A generous dividend could be seen as “bought” with job changes and cuts, hence inflammatory. 

Ironically, this progress to avoid strike action was overlooked; instead, commentators and investors fretted over inherent variability such as on the “global” side while Covid has inevitably impacted demand for IT infrastructure. 

To be rigorous, there is no dividend commitment in this latest update and BT’s cash flow profile did not exactly bring one on. A 63% hike in capital expenditure over £1.5 billion in the three months to end-June meant normalised free cash absorption of £43 million. It makes the extent of pay-out promise look ambitious if due respect is made to latest cash flow. 

Yet the company says: “With trading conditions expected to see some improvement through the year, we have confirmed our outlook and remain confident that BT is on a path to growth.” 

BT Group - financial summary              
year end 31 Mar   2015 2016 2017 2018 2019 2020 2021
Revenue (£ million)   17,851 18,879 24,082 23,746 23,459 22,824 21,370
Operating margin (%) 17.8 17.9 12.3 13.3 14.0 13.8 12.0
Operating profit (£m) 3,181 3,384 2,957 3,163 3,282 3,143 2,569
Net profit (£m)   2,135 2,466 1,908 2,032 2,159 1,734 1,472
Reported EPS (p)   26.1 28.3 19.1 20.4 21.6 17.4 14.6
Normalised EPS (p)   34.0 35.3 33.1 29.6 28.4 21.3 20.5
Operating cashflow/share (p) 58.6 59.1 61.8 49.5 42.7 62.9 59.2
Capital expenditure/share (p) 29.5 28.0 31.5 33.8 36.9 41.2 48.7
Free cashflow/share (p) 29.0 31.1 30.3 15.7 5.8 21.7 10.5
Dividend/share (p)   12.4 14.0 15.4 15.4 15.4 4.6 0.0
Earnings cover (x)   2.1 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
Cash (£m)   3,957 3,914 2,048 3,550 4,880 6,641 4,652
Net debt (£m)   5,811 10,847 10,665 10,725 11,996 19,253 18,185
Net asset value (£m) 808 10,112 8,335 9,911 10,167 14,763 11,679
Net asset value/share (p) 9.7 102 84 100 102 149 118

Source: historic company REFS and company accounts

Hard to assume any trend from a snapshot quarter 

Numbers remained mixed: adjusted operating profit up 3% to £1.9 billion on revenue 3% easier at £5.1 billion; however, pre-tax profit eased 4% to £536 million due to a previous year gain from the sale of Spanish operations. 

A one-off tax charge relating to 25% UK corporation tax rate from April 2023 meant flat after-tax profit of £446 million.

Some £500 million of capital expenditure related to investment in Spectrum radio frequency; one has to assume the CFO knows his budgeting for capex elsewhere too, versus the dividend promise. 

Net debt including financial leases edged up 2% to £18.6 billion, representing net gearing of 44%, for which the last financial year showed a £773 million, net interest charge taking 25% of operating profit. Not ideal but containable while low interest rates persist. 

Shortfall for BT Global is modest in context 

The UK side saw adjusted operating profit up 4% to £523 million on flat revenue of £2.4 billion. Easing of lockdown restrictions benefited BT Sport via the opening of pubs and clubs, and retail stores re-opening, however there was greater competition also from Virgin Media O2. 

Second in group significance, the UK Enterprise (commercial) side eased 5% to £1.3 billion with operating profit up 6% to £429 million. 

In overall context, a 28% fall in operating profit to £102 million for Global was therefore offset; this side constituting 15% of group revenues and just 5% of operating profit.

Covid has disrupted multinationals’ demand for network and IT infrastructure services although a recovery is anticipated in the second half of this year. 

That the UK has offset more challenging trading globally, may partly reflect relative success with Covid vaccines.     

Openreach edged ahead 5% to £1.3 billion and profit by 6% to £773 million, representing 27% and 41% of group totals, respectively. Demand for fibre-to-the-premises (FTTP) should more than offset declines from copper products in the medium term. 

Remember, Ofcom’s ruling last March, how it would keep Openreach free from further wholesale price regulation, was a big plus – that genuinely re-rated BT’s prospects for years ahead. 

12% stake buyer will be taking a strategic view 

Patrick Drahi, a Moroccan-born telecoms investor, declared this position last June via Altice UK – to become BT’s biggest shareholder – if tricky to know his average accumulation price versus a 195p market price at the time. 

It affirmed part of my own case last November: how BT represents the best means of exposure to the government’s intent to substantially achieve FTTP broadband across the UK.  

The 29 July update cited Openreach’s target to grow FTTP from five million currently to 25 million premises by end-2026 compared with five million so far. Mind, that will also facilitate telecom rivals to BT. 

Thorough 5G coverage seems a way off: 90% of the UK targeted by 2028, with 4,500 square miles of new rural 4G coverage by 2025. 

Consumer services package feels the best available 

I have evolved from being a sceptical customer of BT to generally contented bunny. Perhaps there are plenty more like me who may weather price increases than switch supplier, which should be supportive for dividends. 

Although I have had occasional issues – dropped connections – in a rural area, the customer service side and Openreach have improved over the years, and BT has abandoned its infamous Indian call centres. 

Customer retention is fostered by BT’s deal for its broadband customers – of unlimited mobile calling, doubled data allowance and use of the many BT wi-fi hotspots (adjacent to residential homes even) via the BT App. Free McAfee anti-virus/firewall/PC tuning software, and a dependable e-mail service.

Should the broadband service fail at any time, I am promised a 4G router also unlimited download via my phone – to use as a hotspot. It seems a powerful marketing mix; why should one leave BT? 

I am not especially motivated by 5G, but having EE within the group places BT very well to advance this connection which is already automatic via BT SIM cards – and at no extra charge. 

Whereas the investment case for BT used to involve juggling the sense of a sluggish ex-state monopoly with a huge UK customer base, also a history of failed promises, it now appears more capable than ever – of translating its market share into dependable earnings. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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