Does BT Group plc Pass My Triple-Yield Test?

BT Group plc (LON:BT.A) is facing allegations that it is using its broadband monopoly to bolster profits. Is now the time to buy?

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Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

BTHowever, the FTSE 100 is up nearly 90% on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over BT Group (LSE: BT-A) (NYSE: BT.US), to see if it might be an attractive buy. The telecoms giant has gained 350% over the last five years, but has fallen by 14% from its February high.

BT shares also shed more than 2% of their value on Tuesday, following reports that telecoms regulator Ofcom might force BT to reduce the profit margins on its wholesale broadband prices.

Is this a buying opportunity, or should investors hold fire?

The triple-yield test

To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields, and compare them to the returns available from alternative assets. I call this my triple-yield test:

BT Group Value
Current share price 362p
Dividend yield 2.7%
Earnings yield 7.6%
Free cash flow yield 8.2%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.7%
Instant access cash savings rate 1.3%
UK 10yr govt bond yield 2.7%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield.

BT’s earnings yield of 7.6% equates to a P/E of 13.1, which seems undemanding, BT’s free cash flow of 8.2% is impressive, but its dividend yield of 2.7% is less so, and suggests to me either that the shares are too richly valued, or that BT’s giant £6.7bn pension deficit remains a constraint on shareholder returns.

Financial burdens?

While it’s true that pension deficits rarely bring down a company in the way that debt problems can do, a large pension deficit can sap the free cash flow from a company for many years, denying shareholders of a reasonable dividend yield and suppressing a firm’s share price.

I am not comfortable with BT’s pension deficit, especially as the group’s debt levels are also quite high.

Finance costs accounted for 20% of the BT’s operating profits last year, and even if its pension deficit is ignored, BT’s gearing is 137%, which I think is uncomfortably high, and could become a significant burden, as and when interest rates start to rise.

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.

Roland owns shares in Vodafone but does not own shares in BT Group.

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