5 Things you should know before you buy BT shares
Shares in BT (LON:BT.A) are popular with many investors. It’s a big company; a market leader in a safe, steady industry which is relatively insulated from economic turbulence. Most of the time that’s the sort of thing I go for as well. Safe, steady companies, preferably with high yields and high returns without high risks.
So when a subscriber recently asked me for my opinion on BT, I thought I’d crunch some numbers to see how the shares stand up under closer scrutiny.
1. If you’re looking for a solid track record of growth, you won’t find it here
The first thing I like to see in a company is an upward trend in revenues, earnings and dividends over time. I don’t like to rely on investor sentiment to make money in the stock market; I prefer to invest in growing companies so that an increase in the share price is almost inevitable.
Alas, I was somewhat disappointed in BT’s longer-term track record, which you can see below.
Even ignoring the somewhat depressing 2009 figures, things aren’t looking good for BT. The results today are essentially where they were many years ago. That’s not exactly a stellar growth story, so it may be somewhat optimistic to assume high rates of growth in the future. This means that strategy number 1 – pick companies with long histories of consistent growth, goes out of the window.
2. The price to earnings ratio is nothing special either
If you can’t reasonably assume high rates of future growth, a second backup strategy is a share price re-rating. This sometimes happens when a company’s shares are very cheap relative to earnings, perhaps because of some short-term bad news which, given enough time, will pass.
The PE ratio today is around 12.3 which as most experienced investors will tell you, is nothing more than okay. In fact it may be less than okay given that the company shows no signs of reliable growth.
However, I prefer to look at today’s share price relative to the average earnings over the last 10 years. This can give a more consistent indication of a true value investment, and value investments are often the ones that get re-rated upward.
BT’s 10 year earnings average figure comes out at 17.2p, which gives a price to 10 year earnings average figure of 12.7. That’s not bad – in fact it’s lower than the equivalent figure for the FTSE 100, which is currently at 13.3. However, the FTSE 100 does show a fairly consistent upward trend in earnings and therefore probably does deserve to have a small premium in its PE rating.
This means that if you’re looking for a company with a low valuation, BT may not be it.
3. Income investors may not be impressed
A third source of returns is the trusty old dividend. Or perhaps not so trusty in BT’s case. As you can see in the chart above, the dividend took a hefty cut in 2009, in order to make it more sustainable going forward.
The yield today is around 3.8% which is just about the same as the FTSE 100’s yield. One advantage for BT is that the latest annual report suggests that the dividend is set to grow by 10% to 15% a year over the next 3 years. Whether or not that turns out to be the case is another matter.
If dividends do grow by 15% a year then they would go from 8.3p today to 12.6p in 2015. 12.6p is higher than the average full year payment of the last decade, and is higher than any other payment in that time other than the unsustainably high amounts paid out in 2007 and 2008.
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Even if growth is only set at 10% a year then the dividend is still set to grow to 11p, which is still above the average of the last decade.
Are management being over optimistic in their goals for the dividend?
Let’s be generous and say that the dividend does grow at 15% a year in the next 3 years, all the way up to 12.6p. What yield does that give at today’s price of 221p? It comes out at a somewhat attractive 5.7%, which sounds nice on the face of it… if it can be achieved.
On the other hand Vodafone, a company with a very good track record of growing dividends year after year, has a yield of 5.2% today and is therefore less reliant on spectacular dividend growth in the future (although it may still produce it).
So once again, if you’re looking for high yield shares, BT may not be the best place to look.
4. Large debts can be a real drag
By now I would usually have given up my analysis. With little or no long-term growth, a mediocre PE and an average yield, BT is not exactly an obvious bargain. But in the name of thoroughness I’ll carry on, although the general picture doesn’t get any happier.
One of the big threats to any company is the size of its debts. In this case, BT’s debt interest payments are covered by earnings just 4.4 times over. That’s very low, even for a supposedly non-cyclical business like BT. It means that interest payments (£484 million) are eating up cash. It means that shareholders are at risk of a rights issue or worse if the interest payments can’t be met, or if the debt can’t be rolled over in a sustainable fashion.
None of this is good news.
5. Giant pension obligations are not good either
Other than interest bearing debts, there are some other ‘obligation’ based factors that can negatively affect a company. One of them is lease payments, and another is pension plans and their related deficits.
BT has one of the UK’s largest pension schemes and it has a multi-billion pound funding deficit to go with it. Much like interest bearing debts, this is another black hole into which shareholder’s cash can disappear in alarming amounts, year after year. That means saying goodbye to cash that could have either been profitably reinvested for future growth, or returned to shareholders as a dividend.
Is there a silver lining?
Perhaps it’s not all bad. The valuation isn’t excessive – you only have to look back to 1999 when the shared traded for more than 1,000p to see what a really daft valuation looks like. And the company is very likely to still be around in five or ten years, unlike many others.
But when I look at BT I see a company and an investment that screams mediocrity, and mediocrity has rarely been a winning investment strategy.
Filed Under: Value Investing,
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Disclaimer:
This article is for information and discussion purposes only and nothing in it should be construed as a recommendation to invest or otherwise. The value of an investment may fall and an investor may lose all their money. Any investments referred to in this article may not be suitable for all investors. Investors should always seek advice from a qualified investment adviser.
BT Group plc is a communications services company. The Company is engaged in providing and managing data and voice networks and providing a range of services over these networks. It operates in approximately 170 countries worldwide. The Company is a principal communications services provider, selling products and services to consumers, small and medium-sized enterprises and the public sector. The Company also sells wholesale products and services to communications providers in the United Kingdom and around the world. The Company supplies managed networked information technology (IT) services to multinational corporations, domestic businesses and national and local government organizations. Bt has four lines of business: BT Global Services, BT Retail, BT Wholesale and Openreach. In December 2012, the Company sold of its remaining 9.1% iin Tech Mahindra Ltd to institutional investors. more »
8 Comments on this Article show/hide all
Curious.......I rub shoulders with quite a few people at BT - and they all seem to feel that, operationally, things are very much on the up!
IMO the biggest drags of recent years have been the pension position and BT's positioning in the broadband/TV market - and there are signs, I think, that both of these have been turned round. And of course they are confident enough to raise prices as they have announced today.
Rather as with the banks, turning things around at BT is like turning a supertanker - but I think that over-focusing on the recent history by inspecting the wake behind the tanker isn't necessarily the best way to see where it is headed.
FWIW I'd have BT as a core recovery play on the economy, along with some of the banks. Don't own any as yet though.
ee
Hi ee, I hope you're right. If BT can sort themselves out then they'll make another good company to invest in. But I'd need to see them performing well for many years before I feel that I can trust their performance.
In reply to UK Value Investor, post #2
Perhaps so - but they've nearly quadrupled since 2009 and almost in a straight line.......with only one 20% pullback.
I wonder whether your moniker is a misnomer and UK Momentum Investor would be more appropriate ;-)
Thanks for the thread tho'..
In reply to emptyend, post #3
I guess I could be the UK Momentum Investor, if you mean momentum of fundamental business performance rather than share price movements. But I'm talking about 'momentum' over a decade or more rather than a few years, although I'm not quite after Coke's century of growth. I'll leave that to Buffett.
One of the problems with that is that most companies suffer interruptions to their business performance at some point - particularly in the last 5 years or so, when there has been an unprecedented financial system shock that wrong-footed even some of the best managements.
IMO there is a need to distinguish between externally-generated challenges that were genuinely difficult/impossible to plan for (such as the financial crisis) and home-grown screw-ups. Personally I'd be cutting most company managements a good deal of slack in relation to the 2008-2010 period (except for the banks themselves, of course).
BT is burdened with other issues, for example I met a chap working at bt in a fairly senior position who told me that BT had a longstanding agreement with the unions that there would never be any compulsory redundancies. Sounds to me like this makes it a sanctuary for people marking time until retirement, and that it would make it very expensive to get rid of people when needed. no doubt this adds to the burden on the pension funds, as these may be used as a way to tempt people to take early retirement (fine if there is a surplus, but effectively coming off the bottom line if it's in deficit),
G
BT is a pension fund with a telecom's business no the side. I used to own BT but no longer do but I seem to recall the relative size of the pension fund (and its deficit) compared to BT's own market cap is quite staggering. BT is also saddled with a lot of debt and faces huge competition so operational performance "turning the oil tanker around" will not transform the share price.
If equity markets rally and bond discount rates rise (so future pension liabilities fall) then BT's share price will rise whether or not they perform well operationally. The market has known this for years and has priced it accordingly.
Log
In reply to loglorry, post #7
Whilst that might be true as a technicality, it is 100% certainly the case that in the last 5 years BT have been (very) aggressively "managing out" people who are relative poor performers. They have also pruned out long-term contractors. I know literally dozens of people who "used to work for BT". The para above was most certainly a fair criticism of BT 10 years ago - but it isn't now.
Similarly......
That used to be a well-justified one-liner in relation to BT. I may well have written it myself 5 or 6 years ago. But in fact BT has now finally got its arms around the problem of the pension deficit and halved it over the last 4 years, planning to eliminate it completely in a decade. And, if there is some sort of general recovery in the economy, BT actually represents a geared play on the upside, as the pension deficit will be eliminated even faster and revenue growth would flow through to the bottom line (because the debt is a fixed overhead).....hence this comment is wrong:
Of course if the economy doesn't recover then BT will struggle along with everything else but, as I said above, it is a (geared) recovery play on the economy if one is feeling optimistic.
ee