BT Group Plc’s Greatest Weaknesses

Two standout factors undermining an investment in BT Group plc (LON: BT.A)

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When I think of fixed-line telecoms company BT Group (LSE: BT-A) (NYSE: BT.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.

1) Debt

It’s a capital-intensive business building and maintaining a fixed-line telecommunications system, and that seems to show in the level of debt that BT carries. With the firm’s third-quarter results in January, net debts stood at £7,640 million, which is about 2.6 times the level of the previous year’s operating profit.

Given the nature of the firm’s activities and as companies go, that’s not an excessive amount of gearing, and BT has made good recent progress at reducing the ratio of net debt to operating profit, both by increasing its profit levels and reducing borrowings:

Year to March 2009 2010 2011 2012 2013
Net debt 12,607 11,339 9,505 10,155 9,086
Operating profit 301 2,123 2,578 2,919 2,986
Debt divided by profit 42 5.3 3.7 3.5 3

However, I think debt is an area to keep an eye on with BT, as the comparisons to profit may not look as sweet in the depths of the next recession.

BT2) Cyclicality

The great beauty in BT’s business model is that its capital investment in fixed-line assets has potential to earn repeat-revenues for years to come. When consumers sign up for talk or broadband services, for example, they tend to remain for at least a few months. Changing our digital services provider is not something we do every week. Even if we spot a cheaper deal elsewhere, inertia keeps us rooted, so contracts tend to roll around and firms like BT enjoy a constant revenue stream.

However, longer term, BT’s revenue tends to be vulnerable to general economic cycles. We may not change our suppliers every week as consumers, but when times are tough business and residential revenue streams can decline. I think we can see that in the table where BT’s operating profit ramps up from low levels in 2009, when Britain was mired in recession.

What now?

City analysts following BT expect the firm’s earnings to grow by about 9% during the year ending March 2016. Meanwhile, the forward dividend yield is running at around 3.5%.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin does not own shares in BT Group.

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