With dividend income increasingly rare, will BT keep its generous payout or join Shell and cut?
BT (LSE:BT.A) investors await next week's annual results more in hope than expectation after a City bank today slashed its price target and warned that a dividend cut was increasingly likely.
The 'sell' note from analysts at Deutsche Bank lowered their target on BT shares by 25% to just 110p, which is only marginally higher than the multi-year low seen in March's sell-off.
They now think it is only 50% likely that BT's full-year dividend will be kept at last year's 15.4p, having previously thought an expected cut could be deferred for another year while discussions continue with Ofcom about the cost of rolling out full-fibre broadband.
The Covid-19 crisis has added another layer of complexity ahead of Thursday's results, with the pandemic likely to prompt BT to remove guidance for underlying earnings in the 2020/21 financial year. Continued pension top-ups are an additional burden.
A BT dividend cut — while not totally unexpected — would be another huge blow for investors after the loss of the Lloyds Banking Group (LSE:LLOY) pay-out and today's 66% cut by Royal Dutch Shell (LSE:RDSB).
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The direction of travel for BT shares, meanwhile, has been the same as it has been since 2015 when the blue-chip was changing hands at almost 500p. The widely-held stock has failed to join the wider recovery of the FTSE 100 and is currently 38% lower in the year-to-date.
This is 24% worse than BT's peer group, which Deutsche said had been unfairly treated by markets given the sector's defensive position and continued strategic importance.
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BT has lagged the rest on the rollout of fibre-to-the-premises, according to Deutsche, meaning it is under huge pressure to accelerate deployment. BT said in January that its full-fibre build was passing about 26,000 premises a week, taking the total at that point to 2.2 million.
But with a target of four million full-fibre broadband premises by March 2021 and an expected country-wide roll-out by 2025, there is no hiding place for BT investors from the balance sheet strain.
The City's estimate that this will mean higher incremental capex of £500 million a year had previously put analysts on standby for a dividend cut of at least 20%.
Deutsche said today: “We have assumed for quite some time that BT would cut its dividend in respect of 2021 by at least one-third in to support acceleration of full fibre.
“Before the virus impact, we felt that such a decision could be deferred even until the final dividend declaration in May 2021.
“We are no longer so sure, however, as the virus gives cover to cut immediately as BT is likely to remove its prior guidance for EBITDA growth in 2021, which alongside rising capex and continuing pension top ups at current levels could lead to depressed cash flows.”
The bank has cut its earnings estimates for 2021 by 3% to reflect the impact of Covid-19 on roaming revenues and loss of SME business during the lockdown, as well as the potential blow to BT Sport revenues following the cancellation of sporting fixtures.
Only time will tell whether more people working from home in the lockdown will boost longer-term demand for BT broadband. The company is also well placed to capture the full benefits of the 5G roll-out through its ownership of EE.
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In a separate note, Deutsche was much more optimistic about the prospects for Compass Group (LSE:CPG) after it raised its price target by 25% to 1,506p. This comes despite the catering company revealing a week ago that more than half of its sites were closed due to Covid-19 disruption.
While Compass is not paying an interim of final dividend for the year to 30 September, it encouraged the City last week with robust figures for the first six months of the financial year.
As well as cost savings of £450 million a month, the company has secured additional credit facilities of £800 million for a total of £2.8 billion. Shares were 3% lower at 1,378p today.
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