Interactive Investor

Stockwatch: here’s what I’d do with BT shares

Recent results triggered a jump in the share price at this telecoms giant, but is it the beginning of something big or just a blip? After running through the latest numbers, analyst Edmond Jackson gives his view.

7th November 2023 10:10

by Edmond Jackson from interactive investor

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It feels like we’ve been here before. In November 2020, I drew attention to BT Group (LSE:BT.A) as a “buy” at 102p given its declared objective for a 7.7p a share progressive dividend policy – implying the stock had to re-rate because a 7.5% yield was too generous. 

Such a dividend-based approach worked in the sense the stock had doubled by mid-June 2021. Then followed a see-saw period when the shares fell to 130p that October, rebounded to 200p by February 2022, then fell again in the second half of the year to 112p. BT shares rose to 160p last April but were trading at just 110p as recently as Friday 27 October. 

One view is to embrace such volatility, either as a trader and/or investor, steadily accumulating on the drops. BT customers appreciate its gross revenues are irritatingly secure: annual bill rises are pegged to the consumer price index plus 3%. Yes, that cash is significantly being soaked up by full-fibre and 5G roll-out just now, but in due course a classic utility income stock should emerge. 

It was possibly part of the vision of Patrick Drahi, and why the French telecoms billionaire accumulated nearly 25% of BT’s equity at prices at more like 150p. The eight-year table below also shows strong double-digit operating margins, even through the pandemic. 

Yet here we are again, not only low in its market price range, but also BT talking enticingly: 

It said: “We reconfirm our progressive dividend policy, which is to maintain or grow the dividend each year, while taking into consideration factors such as medium-term earnings prospects and business reinvestment.” 

Tell this to analysts, where consensus on the dividend is 7.5p a share in respect of the March 2024 year, and also in 2025, against the 7.7p paid out since 2022 (see table). It is a stretch to describe this as “progressive” except from 2021. BT’s dividend has halved since 2017 to 2019, although with the stock around 124p currently, even 7.5p implies a material 6% yield.    

BT Group - financial summary
Year end 31 Mar

Revenue (£ million)18,87924,08223,74623,45922,82421,37020,84520,715
Operating margin (%)17.912.313.314.013.812.013.412.6
Operating profit (£m)3,3842,9573,1633,2823,1432,5692,7842,614
Net profit (£m)2,4661,9082,0322,1591,7341,4721,2741,905
Reported EPS (p)28.319.120.421.617.414.612.618.9
Normalised EPS (p)35.333.129.628.421.320.517.227.7
Operating cashflow/share (p)59.161.849.542.762.959.258.366.9
Capital expenditure/share (p)28.031.533.836.941.248.745.552.8
Free cashflow/share (p)31.130.315.75.821.710.512.914.1
Dividend/share (p)14.015.415.415.
Earnings cover (x)
Return on equity (%)45.220.722.321.513.911.19.512.8
Cash (£m)3,9142,0483,5504,8806,6414,6523,4563,940
Net debt (£m)10,84710,66510,72511,99619,25318,18518,48919,940
Net asset value (£m)10,1128,3359,91110,16714,76311,67915,29614,514
Net asset value/share (p)10284100102149118154146

Source: historic company REFS and company accounts.

Pension fund liabilities are a key depressant 

BT jumped from 111p after last Thursday’s interim results cited lower-than-expected costs for full-fibre broadband roll-out.  

Installation cost per premises has been at the lower half of a £250 to £350 estimated range, hence cash flow will benefit from lower capital expenditure and is likely to be at the top end of a £1.0 billion to £1.2 billion range. 

Further rises have stalled this week, possibly in awareness of a key reason why the stock sold off before, BT’s pension liabilities having ultimate priority for cash flow. 

As a defined benefit scheme, it guarantees a set pension to members irrespective of investment performance. It pays out £2.5 billion a year, had a £4 billion deficit as of 30 September and plans to be self-sufficient by 2034 - otherwise, extra funding would be needed. 

Trustees turned cautious in the last year, reportedly suggesting the group might ultimately need to put up more cash. I recall at least one broker “sell” note questioning dividend prospects. 

Better equity and bond valuations could yet rescue the fund on a 10-year view, yet meantime keep the stock volatile. Any action liable to disrupt deficit reduction is liable to be vetoed and is why speculation about divestment of Openreach is just that. 

There is comparison with Vodafone’s yield 

A circa 6% yield from BT at 124p compares with Vodafone Group (LSE:VOD) offering potentially just over 9% - assuming consensus for a 7.2p (Vodafone reports in euros) dividend in respect of its year to March 2024, and with the stock currently 78p. 

That looks tight against Vodafone’s expected earnings cover of around one times, yet it has very strong free cash flow – nearly 26p a share equivalent in its March 2023 year – implying near four times cover on what matters. 

Implicitly, the market reckons such cash flow will decline, and along with it Vodafone’s bumper dividends. Yet comparing telecom stocks, some investors may decide to have at least some exposure – enough to limit what cash they might otherwise allocate to BT. 

Vodafone’s £41 billion net debt tends to attract somewhat “distressed” financial risk scores versus “cautious” ones for BT, given its £20 billion net debt. Both stocks may have been helped off recent lows by perception that interest rates have hit a ceiling.  

Little that is special in BT’s interim results 

On a rigorous view, half-year results did not keep up with inflation despite annual customer billing rising more than the cost of living. 

Revenue is virtually unchanged at £10.4 billion, although operating costs have eased 2%, helping operating profit up similarly. Net profit edges up 3%, similarly earnings per share (EPS). 

Net debt has risen 11% over 12 months, hence the interim net finance charge is up 7% to £435 million, taking 25% of operating profit. 

Management dangles a carrot when it says that with two-thirds of gross revenue linked to the consumer price index, revenue and operating profit should grow consistently, such that free cash flow will also improve by at least £1.5 billion by 2030. It also reflects lower expenditure once full-fibre and internet-based phone lines are established. 

For now, the cash flow statement shows £2.3 billion net cash inflow from operations, wholly appropriated by investment activities. Investment spend is however down 11% due to lower fibre-to-the-premises’ installation costs and cash required for this has also eased 11% to £2.5 billion. 

On the financing side, debt proceeds jump 124% to £1.9 billion – management says this is “mainly” due to pension contributions.

“Net free cash flow has substantially offset payment for the final dividend of the March 2023 year,” we’re told. Yet a straightforward overview shows £2.3 billion cash generated, going out as investment. Then, on the financing side, we see how debt proceeds ensure dividends rise 3% to £532 million.  

Given £485 million borrowings were repaid, though it looks as if there has been some debt restructuring. 

As for where this leaves net assets: BT’s per share value is 137p, albeit the £13.6 billion value involved equates to intangibles. Some might say BT’s infrastructure should command more, others how you need to respect debt weighing on the balance sheet. 

Technically and fundamentally still scope for upside 

I suspect there’s a risk of thinking too hard on BT and missing essential points. 

Chart-wise, the stock has roughly revisited net asset value, from where it has rallied several times before – hence affirming that support level. While the past may not inform the future, behaviourally quite a few traders will see a trigger. 

Fundamentally, BT is getting over its capex hump of full-fibre/5G installation, hence should indeed benefit cash flow-wise in due course. 

Yes, telecoms are competitive, but they all seem to raise their bills by CPI inflation plus 3%, and BT’s overall pricing seems decent. I have just renewed a two-year contract and have all my communications with BT given I am satisfied with the service, and there are benefits such as free Norton internet security for devices, also the numerous BT wi-fi hotspots a phone automatically connects to. Having EE within the group seems to ensure comprehensive mobile reception.  

If the pension fund can be managed along, it is therefore possible investors once again regard BT in a better light. Buy.

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

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