According to the Daily Telegraph, yesterday was the worst day BT Group PLC (LON:BT.A) has suffered in more than 30 years.
The telecoms giant cut its forecasts for this year and next after finding that “inappropriate” accounting behaviour in its Italian business was worse than it had previously thought.
The shares plunged from 382.55p on Monday’s close to 303p on Tuesday’s, so is now the time to buy?
You are no doubt expecting a “five reasons to buy BT” item at this point, so here it is.
- The dividend
- The dividend
- The dividend
- The dividend
- The divi
So, the question is: is the divi in danger?
Market cap down by £7.9bn because of a £530mln write-down?
Initially (in October), the write down on its Italian business was £145mln; this has been increased to £530mln, which BT can comfortably afford.
The worry is that this might be the thin end of the wedge.
Think BP and the Deepwater Horizon tragedy.
Think Lloyds and the other banks and the ever escalating payment protection insurance mis-selling provisions.
Sometimes, these things have a habit of growing like Topsy.
It’s probably not going to be as big a money pit as BP’s Macondo disaster, no matter how hard US law firms (currently trying to get their teeth into Tesco) try; but it could escalate.
“The investigation into the financial position of our Italian business is now substantially complete,” BT declared, which is comforting, but what if it is not just Italy?
“We are conducting a broader review of financial processes, systems and controls across the group. The BT Group Remuneration Committee will consider the wider implications of the BT Italy investigation,” BT’s statement said.
The first part of that statement leads to the “can of worms” scenario while as for the latter, it would have to be a hell of a pay cut for BT’s management to compensate for an extra £385mln being set aside for the accounting snafu.
How much wiggle room is there on the dividend cover front?
BT has about 9.96bn shares in issue, and last year (to end-March) it paid a full-year dividend of 14p, which equates to £1.39bn shifting out the door in dividend payments.
Retained profit was £2.59bn, so there is plenty of padding there to enable BT to take a much larger fine on the chin.
Put another way, the divi was 14p, and earnings per share 29.6p.
On the other hand, capital expenditure was a hefty £2.65bn, and although this figure could be trimmed to a certain extent, BT itself warned in its accounts: “Lasting reduction in capital expenditure levels below certain thresholds could affect our ability to invest in mobile telecommunications networks (including additional spectrum), new technology and other BT businesses and so could have an adverse effect on our future growth and the value of radio spectrum.”
If push comes to shove, the divi will go before the capex is slashed too far.
Not the only cloud on the horizon
All of which would be fine if one could guarantee that this year would be much the same as last year, albeit with added accounting scandals.
Unfortunately, BT also warned “the outlook for UK public sector and international corporate markets has deteriorated”.
George Salmon, equity analyst at Hargreaves Lansdown noted that: “With news that its Business and Public Sector division is coming under pressure too, worries about the group’s ability to fund its generous dividend policy will surely grow.”
Salmon makes the point that with net debts of around £9.6bn following the acquisition of mobile network EE, the Italian accounting scandal has come at a bad time.
P-p-p-pick up a pension
Old timers might remember when BT used to be part of something called the General Post Office, or GPO for short.
One of the legacies of its time as a publicly owned company is a ma-hoosive pension deficit.
The defined benefit pension scheme has more than 300,000 members and pays out more than £2bn a year in benefit payments.
Note that this comes from a pension fund, not from BT, and the scheme was closed to new entrants in 2001.
Except the fund’s deficit is so large that in 2015/6 BT had to chip in £880mln to the fund to plug some holes, and the year before that £876mln and the year before that £325mln.
Some might argue that the pension deficit will take care of itself in time when interest rates start to rise and others still would argue it would take care of itself a sight sooner if the fund manager looked for better yielding alternatives to bonds. But the fact remains it looks like there will be a requirement for some time to make hefty contributions to the fund.
Over-reach and Openreach
It took a long while for BT to shake off its image as a glorified utility company grown fat and lazy on an entrenched monopoly.
The direct challenge to Sky TV’s monopoly over sporting events on pay TV and the move back, decades after disposing of Cellnet, into mobile phone networks with the acquisition of EE encouraged analysts to at least make a pretence of regarding BT as a growth company.
All of that has come at a cost – hence the debt mountain – but you do not hear too many people questioning the validity of these strategic moves.
As for that entrenched monopoly, it is still there, although industry watchdog Ofcom is proving terrier-like in its concerns over how Openreach, BT’s networks arm, is governed.
If it means BT has to go back for a while to being a utility and sweat its assets – the group recently announced plans to start charging broadband and phone customers for its BT Sport channel from April - then it should be capable of doing so in order to protect the dividend.
Investment research house Morningstar recently cut its fair value estimate of BT shares from 400p to 370p following this week’s trading update, but thinks the share price fall has been overdone.
“We believe the market is projecting that similar accounting practices have occurred in other countries. While we acknowledge that this is a risk, we don't believe it is likely,” said Morningstar analyst Allan Nichols, whose middle initial, in case you should need to know, is “C”.
The Italian management team has been replaced, Nicholls noted.
Ken Odeluga, a market analyst at spread betting firm City Index, thinks more members of the management team could end up being thrown under the bus to appease the angry market deities.
“There’s no evidence that chief executive Gavin Patterson had any inkling before last autumn of the malfeasance abroad,” Odeluga said.
Is there a “but” coming?
Yes, there is.
“Culpability is lacking, but failure to spot the issue still puts Patterson in the frame in the eyes of many shareholders,” Odeluga believes.
“That makes sense. Making no changes ‘upstairs’ would compound a conduct issue with a strategic misstep in BT’s game of brinkmanship with Ofcom over Openreach,” he added.
“With dividend guidance now affirming at least 20% growth by end-2017/18—well above more expensively rated SKY—BT’s valuation even starts to look attractive after Tuesday’s rout; however, the pension deficit as a proportion of market cap has risen too. That makes a ‘reset’ in the C-Suite even more urgent,” Odeluga said.
Thank you, Ken, and I am glad you mentioned that avowed commitment by BT’s management to stick to its plans to grow the dividend by at least 10% a share both this year and next.
Would it have said that had it not been confident of being able to fulfil that pledge?
Well, as Mandy Rice-Davies (ask your grandfather) might have put it: they would say that, wouldn’t they?
So, it is up to you to determine whether that juicy 5% yield is as safe as it looks.
People still have sock drawers, but they tend not to have share certificates any more. If they did, and you were a holder of BT, it would probably be wise to tuck them away in the sock drawer, bank the dividends each year, and otherwise forget about them until you retire – or you need to sell them to pay for the exorbitant charges for BT Sport.