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Why I’d sell BT Group plc despite 10% gain

Photo: Albert Bridge. Cropped. Licence: http://creativecommons.org/licenses/by-sa/2.0/

This year has been eventful for BT (LSE: BT.A). Already it has released a profit warning, had its Italian operations investigated and agreed to major changes in the way Openreach will be run. This has led to high volatility in its share price, with a fall of as much as 17% since the start of the year. However, in the last eight weeks it has risen by around 10%. Despite this comeback, it appears to be worth avoiding at the present time.

Potential challenges

BT faces a highly competitive industry outlook. A number of major rivals have sought to diversify their operations and differentiate their products from the competition. BT has done the same and has purchased EE in order to become a major quad-play operator. This means that it offers broadband, pay-TV, landline and mobile services. While it did offer all four services prior to the EE deal, the acquisition of the UK’s largest mobile network means that it is now a dominant quad-play operator.

However, the risks involved with integrating such a major business into BT may have been overlooked by investors. The EE deal meant that a major reorganisation was necessary. While it is apparently progressing as planned, there is a chance there could be a disappointment when it comes to cross-selling, or in how the different parts of the business interact with one another. Generating efficiencies can also prove to be more challenging and at a time when BT’s management team is already focused on the Openreach deal as well as the Italian investigation, the integration of EE could suffer.

BT also faces a large bill in order to maintain its commitment to sports rights. Sky is showing little sign of pulling back on its investment in football and other sports rights. Therefore, the cost to BT of keeping up with the competition could be significant. This may mean that investment in other parts of its business suffers, or else prices may have to rise. This could make it less competitive relative to its rivals and lead to slower profit growth.

Risk/reward opportunities

As well as operational risks, the company faces financial risks. Its pension obligations remain vast and its debt levels may also cause issues should interest rates rise over the medium term. With a debt-to-equity ratio of 137% and a pension liability of almost £6.4bn, BT’s balance sheet remains highly leveraged and relatively risky. And with its bottom line due to rise by just 3% next year and 5% the year after, its price-to-earnings growth (PEG) ratio of 2.4 lacks appeal given the risks it faces over the long run.

Due to this, sector peer Talktalk (LSE: TALK) seems to be a better option for investors. It is forecast to record a rise in its bottom line of 8% next year and 10% the year after. This puts it on a PEG ratio of just 1.1, which indicates its shares could deliver high capital gains. Certainly, Talktalk has endured a difficult period, with the hacking scandal hurting investor sentiment. However, with a new CEO likely to refresh its strategy and a true quad-play offering which offers cross-selling potential, it appears to be a better buy than BT.

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Peter Stephens owns shares of TalkTalk Telecom Group plc. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.