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How Safe Is Your Money In BT Group plc?

BT Group (LSE: BT-A) (NYSE: BT.US) reported its final results for the year to 31 March a few weeks ago, but after spiking up by more than 4% on results day, BT’s share price has returned to its pre-results level of around 370p.

Although BT satisfied investors’ immediate demands with a 15% dividend hike, its pension deficit remains stubbornly above £7.0bn, while debt levels remain high.

BTBT Sport also remains a concern, for me. Although the channel’s free status is attracting new broadband customers, this trend could reverse when BT starts charging for BT Sport, which is expected to happen next year.

To find out more, I’ve taken a close look at last week’s figures, and have crunched the numbers on three key ratios that should provide a clearer picture of BT’s underlying financial strength.

1. Interest cover

What we’re looking for here is a ratio of at least 2, to show that BT’s earnings cover its interest payments with room to spare:

Operating profit / net interest costs = interest cover

£3,421m / £608m = 5.6 times cover

BT’s operating profits covered its interest costs 5.6 times last year, providing adequate protection from falling profits or rising debt costs.

2. Gearing

Gearing is simply the ratio of debt to shareholder equity, or book value (total assets – total liabilities). I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.

At the end of 2013, BT reported net debt of £7.4bn, but its overall equity is negative, thanks to the firm’s £7.0bn pension deficit, which rose by 20% last year. Even if we ignore this worrying problem, BT’s gearing is 114%.

BT’s combination of massive pension deficit and above-average debt levels doesn’t fill me with confidence, as both of these obligations rank above dividend payments, when money is tight.

3. Operating margin

BT’s operating margin was 17% last year, a strong result that suggests the firm should be able to generate decent levels of free cash flow to fund capital expenditure and dividends.

Indeed, BT reported free cash flow of £2,171m last year, highlighting the underlying strength of the business, as long as it can manage capital expenditure tightly enough to provide upgraded services for consumers, without making shareholder returns unaffordable.

Buy BT?

In my view, BT isn’t quite cheap enough to buy, but remains a solid hold for existing shareholders.

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Roland does not own shares in BT Group.