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BT's enterprise arm facing top-line pressures but cost cuts offer support, says Barclays

Barclays expects BT’s revenues to fall 1.5% and earnings to drop 5.6% in the third quarter
BT reports its third quarter results on January 31

BT Group PLC’s (LON:BT.A) newly formed enterprise division is facing top-line pressures that are unlikely to abate any time soon, Barclays said ahead of the telecom firm’s third-quarter results next week.

The company has merged its business and public sector divisions with the wholesale and ventures arm to create BT Enterprise to streamline its operations.

Barclays thinks Q3 consensus forecasts are too low

The businesses have been combined since May 2018 but BT has continued to report the figures separately. On January 31, BT’s third-quarter results will for the first time, include numbers from the merged business.

“A deep dive on BT’s newly formed enterprise division (30% of enterprise value, 40% of free cash flow) shows how the division has been a successful and high-return on capital employed cash cow for BT for years,” Barclays said.

“It does however also show clear top-line pressures, which are unlikely to abate any time soon due to structurally declining revenue trends that are exceeding newer growth areas, driven in part by technology disruption.

“We believe continued cost-cutting should support the division going forward – a theme likely to persist at the upcoming 3Q results, where expectations appear low.”

Barclays expects BT’s revenues to fall 1.5% to £5.98bn in the third quarter, compared to consensus estimates for a 2.3% decline to £5.93bn. The bank predicts group earnings (EBITDA) will drop 5.6% to £1.83bn, better than the consensus for a 6.2% decrease to £1.82bn.

In the third quarter of last year, revenue amounted to £6.07bn and EBITDA totalled £1.94bn.

In November, BT said it expects full-year earnings to reach the top end of its guidance range after first-half pre-tax profit rose 24% to £1.3bn, supported by cost savings and the sale of high-end smartphones.

READ: BT shares surge despite dividend cut as it expects earnings to hit top end of guidance

However, regulated price reductions in its Openreach network and a poor performance in its enterprise businesses dragged revenue down 2% on a reported basis to £11.6bn.

Barclays said cost-cutting will support near-term estimates and free-cash flow (FCF). Longer-term, FCF could be threatened by risks arising from consumer pricing and Openreach’s commitment to upgrading the UK’s broadband infrastructure, the bank said.

Barclays maintained an ‘equal weight’ rating and target price of 250p on the stock.

Berenberg maintains 'buy' rating on BT

Berenberg was more positive on BT, repeating a ‘buy’ recommendation and target price of 275p. The broker thinks the recent underperformance in BT’s shares is unwarranted.

“BT has been one of the weaker shares in the FTSE 100 and telecoms sector in recent months,” it said.

“We find this odd, given that newsflow has included: 1) the likelihood of a softer Brexit increasing, which is good for BT’s pension deficit; 2) sensible plans from Ofcom on how to auction 700MHz and 3.6-3.8GHz spectrum, prioritising coverage over creating bidding tension; 3) BT linking fixed-line price increases to inflation, creating a mild forecast headwind, but de-risking Ofcom’s pricing review; and 4) rumours that BT is progressing the sale its troubled Italian operations.”

Brexit de-risking has 'further to run'

Berenberg added that BT’s third-quarter results should leave full-year guidance “looking easy” and believes Brexit de-risking has further to run.

“If the UK now reaches a softer Brexit outcome and interest rates normalise over the years and decades ahead, much of the recent increase in liabilities could partially unwind,” it said.

The shares have been weighed down by concerns that BT is under pressure to increase spending on bringing fibre broadband to homes and businesses after Ofcom said the company was “well positioned to invest significantly in fibre”.

Investors are also worried about an expected decline in third-quarter earnings and the fact that new boss Philip Janson is unlikely to have a strategy ready to present just yet.

Berenberg expects Jansen to outlay his vision at the full year results in May.

The bank said if third-quarter results meet consensus forecasts, BT will only need to achieve an EBITDA decrease of 7% to 9%  and a normalised FCF drop of 13% to 33% to achieve full year guidance. Unlike the third quarter, the fourth quarter will not include a big hit from the adoption of IFRS 15 accounting measures.

Berenberg sees risk to dividend beyond two-year commitment

Berenberg predicts revenue of £5.92bn and EBITDA of £1.80bn for the third quarter.

“Beyond Q3 and Brexit visibility, we view the middle of this year with caution, seeing May’s full-year results as Mr Jansen’s opportunity to outlay his vision, including risk to medium-term capex and dividend beyond the current two-year commitment of 15.4p,” Berenberg said.

“We are positive in the longer term on: 1) cost transformation; 2) cash flow upgrades from a possible retrenchment of BT Sport; 3) increased collaboration with Deutsche Telekom; and 4) pension deficit inputs to be proven too conservative in the very long term.”

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May 09 2019

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