Shares in BT Group (LSE: BT-A) slumped by 18% on Tuesday morning, after the telecoms giant revealed the full effect of adventurous accounting at its Italian business — the scandal now looks set to blow a £530m hole in the firm’s finances.
But the Italian unit only contributed 1% to EBITDA last year, so I can’t help wondering if investors had been getting cold feet over the telecoms business and were looking for an excuse to dump shares.
It’s made me examine Vodafone (LSE: VOD) too, whose share price has also dipped since Tuesday, standing today at 193p. I’ve been watching Vodafone for some years, convinced that the shares have been overpriced, and we’ve now seen them fall 25% since the end of May 2015.
Vodafone shares are trading on a forward P/E multiple of nearly 35 now, and that’s more that twice the long-term average of the FTSE 100 that stands at around 14. I think that’s been propped up by two things.
Big dividend
One is the ongoing hopes for some sort of takeover or merger, but I reckon investing on that basis is a mug’s game. The other is Vodafone’s high dividend payments, which look set to yield 6% for the year to March 2017, and forecasts have that rising as high as 6.3% by 2019.
But here’s the problem… Vodafone’s earnings aren’t anywhere near enough to cover that amount of cash, and haven’t been since the company sold off its stake in Verizon Wireless. Those payouts have been met by handing out the firm’s capital and by accumulating debt — adjusted net debt stood at £9.6bn at the halfway stage in September, up sharply from £3.7bn a year previously.
And even though analysts are predicting impressive EPS growth over the next three years, that would come after a three-year slump, so even by March 2019 we’d still see earnings covering only about 70% of the forecast dividend payment.
I reckon Vodafone needs to cut its dividend, and it needs to do it now. And the share price needs to fall further to get back to a reasonable valuation.
Which one should you buy?
But where does that leave BT? Well, its shares are valued as if we’re looking at a commodities company rather than a tech high-flyer. And you know what? I reckon that’s exactly right, because that’s what telecommunications really is these days. I can’t tell the difference between telecoms offerings these days — they all work just about the same, whoever you get the service from. On top of that, providers face continuing upgrade costs as bandwidth increases, but competition keeps retails prices low.
But BT is also expanding into delivering its own content, which is surely where future telecoms competition will shift as it’s about the only way to generate product differentiation these days — and BT Sport has been a big winner so far.
Beyond 2017, analysts are predicting single-digit EPS rises for BT, and with the share price depressed, we’re looking at P/E multiples dropping to under nine by March 2019 — way below Vodafone’s.
BT’s dividend has been nicely progressive for years too. At 4% this year and still climbing, it’s around twice covered by earnings and really does look sustainable. BT is carrying similar net debt to Vodafone, but of the two I see it as the better buy – and Vodafone still looks like a sell to me.
