I’ll be honest — I’ve never quite seen the appeal of BT Group (LSE: BT-A) (NYSE: BT.US) as an investment. Although its near-monopoly on the UK’s fixed-line broadband network should make it a long-term cash cow that pays great dividends, it hasn’t always worked out that way.
However, there’s no doubt that I’ve missed out on profiting from one of the FTSE 100’s star performers in recent years — BT shares have delivered an average annual total return of 36% over the last five years, compared to 12.9% for the FTSE 100.
Can this outperformance be sustained?
BT’s operating margin in 2013/14 was a very healthy 17.2%. That’s impressive by any standard, and compares well with telecoms peer Vodafone, which reported an adjusted operating profit of just 11%, once earnings from Verizon Wireless were stripped out.
Even BT’s smaller, nimbler peer KCOM failed to do better: it only managed an operating margin of 14.9% last year.
The picture is less rosy when it comes to debt: even if we ignore BT’s monster £7bn pension deficit, BT’s net gearing is 114%.
I’m uncomfortable with this for a number of reasons. Firstly, we can’t ignore BT’s pension deficit, as it requires a fixed £325m deficit payment each year until 2021. This adds around 50% to BT’s debt servicing costs, and in 2013/14, BT spent £939m on interest payments and the £325m pension top-up, eating into the free cash flow available for its dividend payments.
Although BT’s adjusted figures and rising dividend appear to tell a growth story, some of the firm’s other figures suggest that growth is minimal, at best.
For example, BT reported zero revenue growth last year. The firm’s earnings before interest, tax, depreciation and amortisation (EBITDA) — a useful measure of underlying performance — were also flat last year.
Although one of BT’s favoured measures of performance, normalised free cash flow, rose by 7% last year, I do have some reservations about the quality of this metric: it excludes both the cost of telecommunications licences and the firm’s annual £325m pension top-up, both of which are an essential and regular part of its business, and should not be treated as exceptions, in my opinion.
Where better for dividend growth?
BT has a very shaky record when it comes to dividend growth — payouts were cancelled in 2001 and 2002, and after rising rapidly were then slashed by 59% in 2008/9.
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Roland owns shares in Vodafone, but does not own shares in BT Group or KCOM. The Motley Fool has recommended KCOM.