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How Will BT Group plc Fare In 2014?

For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.

That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.

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To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:

  • Prospects;
  • Risks;
  • Valuation.

Today, I’m looking at fixed line telecoms company BT Group (LSE: BT-A) (NYSE: BT.US).

Track record

With the shares at 374p, BT Group’s market cap. is £29,585 million.

This table summarises the firm’s recent financial record:

Year to March 2009 2010 2011 2012 2013
Revenue (£m) 21,390 20,859 20,076 18,897 18,017
Net cash from operations (£m) 4,706 4,825 4,566 3,558 5,295
Adjusted earnings per share 16p 17.3p 21p 23.7p 26.6p
Dividend per share 6.5p 6.9p 7.4p 8.3p 9.5p

1) Prospects

The provision of broadband-based consumer and business services is very important to BT. Subscriptions to the firm’s fibre optic service have increased from around 0.5 million to two million or so during 2013. That’s fast growth, but the potential is still huge, as the company has rolled out fibre availability to about 17 million premises in the UK so far. Things are going well, with the recent half-time results trumpeting that the most recent quarter was the strongest ever for fibre take-up with net connections up 70%.

Although BT operates in more than 170 countries, last year it generated most of its operating profit in the UK. The firm’s Global Services division provided around 31% of revenue with a break-even trading result providing no contribution to profits. One of the company’s stated aims is to become a global leader with its Global Services division, which implies potential for profit growth abroad if the firm continues to focus on developing its overseas operations.

2) Risks

In one strategy, BT is offering BT Sport free to its broadband subscribers. The service includes Champions’ League football, which BT won the rights to broadcast by outbidding the competition in a three-year deal costing £897m. BT broadband users also get unlimited free WiFi use, which could become ever more attractive to consumers in the modern world of increasing mobile device usage.

I think these are clever, moat-building strategies that could potentially nutmeg competition from other broadband providers and help to drive future growth. The risk here is the lofty sums being paid for exclusive sports broadcasting rights and the potential for BT to be outbid in the future, which could lead to BT’s advantage being eroded, particularly if a broadband competitor manoeuvres into a position to offer a better deal.

A further risk exists in the cyclicality of the industry. When economic times are tough BT’s business tends to drop off a bit and the firm’s net debt levels, currently around three times operating profit, could become problematic.

 3) Valuation

I’m kicking myself for not buying BT shares in 2010 at about 120p after looking at the opportunity. Today’s 374p is showing investors a 200% gain since then. At this price, the forward dividend yield is about 3.3%, and city analysts are expecting forward earnings to cover the dividend about 2.3 times in 2015.

Investors can buy into that income stream for a forward P/E multiple of around 12.9, which compares to earnings expected to grow by 13%. That looks like a fair price, but the shares have risen fast and may be due a cooling off.

Conclusion

BT Group seems to be executing a decent growth strategy and looks attractive as a long-term investment. I’m happy to keep the shares on watch in the hope of a better entry point on any market stumble.

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> Kevin does not own shares in BT Group.

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