Interactive Investor

Stockwatch: prospects for BT after union rejects pay offer

19th April 2022 11:30

Edmond Jackson from interactive investor

There’s a decent dividend yield and significant market share, but should you be worried by the prospect of a strike ballot at BT? Our companies analyst gives his view. 

With a proposed ballot for strike action after mushy third-quarter numbers to end-December, exactly how “defensive” are shares in BT Group (LSE:BT.A)

Telecom stocks - especially BT, the ex-state monopoly with a very strong market share – are seen as defensive, given essential services offer relative freedom to price. Despite rising living costs, people would rather forego a few meals out than disconnect from the internet. 

Strong UK market share but also aiding rivals 

Somewhat ironically, BT’s strength continues to be expressed by way of a 41% share of landlines (including its EE subsidiary) followed by Sky at 22%, Virgin Media at 22% and TalkTalk at 8%. Yet landline calls are in decline versus mobile, and fibre-to-the-premises (FTTP) broadband is taking over – at least for now.  

Part of BT’s “growth” narrative is its Openreach subsidiary vigorously installing such connections, with a 37% increase during the final three months of 2021. Ofcom regulations however require Openreach to maintain the network to facilitate competition, and on a five-to-ten year view I would expect to see mobile broadband predominate, along with 5G. 

4G/5G differs in the sense of not being reliant on Openreach, and a key advantage already of Virgin Media is lightning-quick broadband speeds – for those who so desire. I am inclined to see FTTP as an intermediate technology and Openreach eventually becoming less significant.  

I therefore question the timescale for which FTTP is value-generating for BT. It should be in the short to medium term as an enabler of higher-cost “full fibre” packages, then BT can push through annual price rises pegged at least to inflation. 

Not to diss BT’s strength of market position, just want to add a pinch of salt to its recent results’ narrative – that is ambiguous as to whether “capital expenditure up 24% to £3.8 billion” in the third quarter alone, is value-accretive to BT in the long run. 

Openreach momentum aided the third-quarter results 

Normalised free cash flow was one of the better variables from the results: up 6% to £878 million relative to pre-tax profit easing 3%, chiefly due to higher finance costs. 

A 2% slip in group revenue was due to the international side falling 11% over nine months which improved to a 4% slip in the third quarter; and the enterprise business. down 5% and worsened to 6% in the third quarter.  

Meanwhile, a hard sell for full fibre broadband mitigated the consumer decline to 1% both in a nine and three-month context, and Openreach rose 4% over both periods. 

It is a mixed picture where I suspect cost-cutting by business customers helps explain why BT guides for a 2% decline in revenue for the full year to 31 March - despite blaming Covid and supply chain issues. 

If the UK flirts with recession this year, as economists now expect, this mushy revenue profile seems likely to continue. The best momentum for FTTP connections may be over – at least short-term – as people can quite easily defer such an upgrade. The margin benefit may therefore also ease. 

With BT bills rising 9.3% last March after the UK inflation rate hit 5.4% in January, it is already a big increase for people to adapt to. Yes, most wages are rising, but they ingrain inflation hence future billing hikes. 

5G is another key aspect of BT’s “growth” pitch where it now covers over 40% of the UK population with network leadership. This may however be a case of running fast to stand still – in value terms – as all providers are shifting to 5G and, as a BT customer, I am told my SIM card would automatically pick up 5G where available – under my existing mobile package.  

For the March 2023 year, consensus looks for just over £2 billion of revenue after £1.8 billion for the March 2022 year. Top-line growth seems speculative given one or more quarters during this period could see UK economic contraction. 

Interest rates seem set also to rise modestly on £17.7 billion net debt which is up 2% on a year ago. A £382 million interim net finance charge took 24% from £1.6 billion operating profit.  

The anticipated 7.7p a share dividend in respect of 2022, rising to 7.8p this year, would take around £775 million – hence potentially a close shave versus capex commitments, especially if the unionised workforce digs in for a better pay award. 

BT Group - financial summary
Year end 31 Mar

Revenue (£ million)18,87924,08223,74623,45922,82421,370
Operating margin (%)17.912.313.314.013.812.0
Operating profit (£m)3,3842,9573,1633,2823,1432,569
Net profit (£m)2,4661,9082,0322,1591,7341,472
Reported EPS (p)28.319.120.421.617.414.6
Normalised EPS (p)35.333.129.628.421.320.5
Operating cashflow/share (p)59.161.849.542.762.959.2
Capital expenditure/share (p)28.031.533.836.941.248.7
Free cashflow/share (p)31.130.315.75.821.710.5
Dividend/share (p)14.015.415.415.44.60.0
Earnings cover (x)
Return on equity (%)45.220.722.321.513.911.1
Cash (£m)3,9142,0483,5504,8806,6414,652
Net debt (£m)10,84710,66510,72511,99619,25318,185
Net asset value (£m)10,1128,3359,91110,16714,76311,679
Net asset value/share (p)10284100102149118

Source: historic company REFS and company accounts

Is the threat of strike action chiefly bluster, like before? 

During a national radio phone-in last Thursday evening, Dave Ward, head of the communications workers union (CWU), agreed strongly with a caller purporting to represent BT workers - who said it was a waste of time talking with CEO Philip Jansen “who lives in another world with no idea of the realities workers face”. 

Furthermore, Ward pushed for a UK general strike as a part of the agenda for an 18 June rally in London.  

This could be a familiar pattern of trade unionist chest-beating followed by compromise, like has happened quite recently at BT and Royal Mail.  

But, as yet, and despite a £1,500 pay rise offer to 58,000 staff – at the cost of £90 million – the CWU’s line is “no choice but to prepare for a statutory industrial ballot”. 

BT says its offer works out at an 8% increase for some staff and 3% for the highest-paid. The CWU wants a 10% rise generally, which would present a dilemma for BT management in terms of future price increases and meeting dividend expectations. 

The CWU can point to circa £775 million going out as dividends to justify a tougher stance. 

This strike story therefore needs watching despite union tendencies to make big threats then compromise – most likely why the stock market takes relatively little notice.  

After dropping from around 200p to 164p with the invasion of Ukraine, BT shares had rebounded to 194p by 12 April – easing last week to 187p. Meanwhile, Vodafone edged up slightly to 132p last week. 

Consolidation seems likely in months ahead 

Barring an early breakthrough on the industrial relations front, BT shares seems likely to tread water – given no firm bullish or bearish theme. 

A prospective yield of 4.2% compares with 6.8% at Vodafone if the latter maintains a circa 9p a share pay-out in respect of 2022 and 2023 – in line with recent consensus.  

BT does, however, enjoy expectations for stronger earnings cover at 2.7x versus 1.2x for Vodafone. 

No date appears set for a ballot, but if strike action gains support, then it would be logical for the market to exact a higher yield - also in respect of risks to the pay-out increasing – by marking down the stock. 

When I drew attention to BT as a “buy” at 102p in November 2020, I was aware then how it could be a close shave to deliver on a 7.7p a share progressive dividend policy, as entertained. Admittedly, that did not inflame workers to back strike action like the CWU called for a year ago, so why should it now? 

Overall, I believe the workforce will be realistic to accept BT’s current offer, although the CWU can exploit the differential in cash going out as dividends versus pay rises. Hold. 

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

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