The BT Group (LSE: BT-A) share price was flat on Friday morning after chief executive Gavin Patterson announced plans to leave the firm.
According to today’s announcement, Mr Patterson will stay on until a replacement CEO is found, which is expected to be later this year. Chairman Jan du Plessis reiterated the board’s support for the firm’s current strategy, but said that “the broader reaction to our recent results” had left him convinced that “a change of leadership was required”.
In other words, discussions with major shareholders had confirmed that they wanted someone new in charge.
Good news for shareholders?
As a shareholder myself, I’m pleased with this news. Since Mr Patterson took charge in 2013, the group’s revenue has risen by an average of 5% each year, but after-tax profit has been almost flat. Profit margins are down and the group’s debt and pension deficit remain a problem.
Mr Patterson’s decision to spend more than £5bn on sports rights has always seemed unwise to me. As the UK’s incumbent telecoms provider, I believe the group’s focus should have been on rolling out a universal fibre network and on EE in order to provide integrated mobile, voice and data services.
BT’s new strategy does finally prioritise network upgrades and the integration of EE. A total of 13,000 job cuts are planned as the two companies are combined. Annual cost savings are expected to reach £1.5bn by the third year of the programme, helping to fund the £3.7bn per year the company plans to spend on upgrading its mobile and fibre networks.
Is the 8% dividend yield safe?
BT’s share price has fallen by a third over the last year and by 50% over the last two years. But the group’s dividend has been left unchanged over the same period, resulting in a turbo-charged yield of almost 8%.
Mr Patterson has always been reluctant to cut the dividend. But the existing 15.4p per share payout costs about £1.5bn each year. Last year, dividends swallowed up about 75% of the group’s after-tax profit of £2bn.
I don’t think this is affordable. I expect the dividend to be cut by between 30% and 50%, to provide room for future dividend growth and to free up cash to fund the group’s turnaround.
Although this might sound like bad news, it’s worth remembering that a 40% cut would still give the stock a forecast yield of 4.5% at the current share price. That’s well above the FTSE 100 average of 3.8%.
Why I’d buy
At the end of last year, BT reported net debt of £9.6bn and an £11.3bn pension deficit. Both figures are uncomfortably high, in my opinion, but they shouldn’t be unmanageable.
A new 13-year plan provides certainty on pension deficit payments and the group’s borrowing costs are fairly low. More importantly, this information is already in the public domain, so it should be reflected in the current share price.
I’d argue that BT’s financials aren’t necessarily as bad as they seem at first glance. The group’s cash generation has remained good, even as profits have fallen. I estimate that free cash flow last year was about £1.6bn, putting the stock on a trailing price/free cash flow ratio of 12.5, which isn’t bad at all.
The shares also look affordable on another measure favoured by City analysts, EV/EBITDA. This compares enterprise value (market cap plus net debt) with earnings before interest, tax, depreciation and amortisation. The firm’s EV/EBITDA ratio is about 4, which is attractively low.
The stock now trades on less than 8 times forecast earnings. At this level, I think BT offers value as a long-term turnaround buy.
