Before the company’s disastrous profit warning at the end of January, shares in BT (LSE: BT-A) had declined by around 20% excluding dividends over the previous 12 months. These declines were fuelled by investors’ concern about its outlook in the face of increasing competition, pressure from regulators, rising debt and pension costs.
Unfortunately, many of these issues continue to hang over the company. Add into the mix the fact that BT is now taking considerable flack and may face an SFO investigation into its problems in Italy, and you have a deadly cocktail of problems hanging over the business.
There are so many issues now hanging over BT, shares in the company may struggle to ever return to 500p.
Multiple issues
The problem at BT’s Italian division is just one of the many challenges now facing the group. Even though the Italian matters have forced the company to book a £530m charge, in the grand scheme of things, this cost is relatively insignificant.
Indeed, compared to BT’s debt of £9.6bn and October pension deficit of £11.5bn, the £530m is a rounding error.
According to rating agency Moody’s, BT’s debts are now expected to be 3.5 times its underlying earnings this year and 3.4 times next year, nearly 50% more than the standard limit for Moody’s Baa1 credit rating, which is only two levels away from junk.
If BT’s debt continues to grow, the company will find itself falling out with creditors, which will lead to higher interest rates and declining profits. However, the company may have no option in the matter as it continues to spend on expensive sports broadcasting rights and mobile spectrum for its newly acquired mobile network EE. At the same time, competition in the broadband and home phone market continues to increase leaving BT little choice but to hike prices to maintain revenue growth.
According to Ofcom, BT has increased line rental fees charged to customers by 41% in recent years, despite wholesale costs falling 25%. Ofcom is demanding BT legally separate from its network division, Openreach, which would likely give the company less control over the market and only increase competition. At the moment BT via Openreach provides network services to other providers like Sky, Virgin, and Talktalk. Other providers such as City Fiber are already bypassing Openreach, and if more firms take this route, the pressure on BT will continue to grow. Regulators are likely to favour this route rather than continuing to allow it to maintain its grip over the country’s telecoms network.
The bottom line
All of the above issues combined add up to give a very bleak outlook for the firm. By having to legally separate from Openreach, it will lose its key competitive advantage, and it’s not possible to tell how exactly this will impact the company in the long term.
With uncertainty about BT’s outlook growing and its financial position deteriorating, investors are likely to give the shares a wide berth for some time to come.
