In October, BT Group (LSE: BT-A) told us it was looking into “accounting errors” in its Italian business. At the time, the result a writedown of around £145m was thought likely.
When the results of further investigation were announced in January, we heard that “the extent and complexity of inappropriate behaviour in the Italian business were far greater than previously identified“, leading to the “overstatement of earnings in our Italian business over a number of years“. The final cost is now put at around £530m, and it’s going to hurt this year’s profits.
That sent the shares down 20% on the day, and though they’ve crept back to 323p today, we’re still looking at a 30% fall in the past 12 months from above the 450p level. How soon can the shares recover and break 400p again?
Over-reaction
I reckon it could be earlier than many people think. As so often happens, there’s been a big over-reaction to a short-term shock, and the price has already recovered 7% since 26 January. And though BT’s stated profits will be hurt in the short term, it’s going to have little effect on the firm’s long-term business — in fact, BT told us that the “EBITDA contribution of the Italian business included in the group’s reported EBITDA for the financial year ended 31 March 2016 was around 1%“.
Until the January surprise, a number of brokers had share price targets out of 400p or greater for BT. Those are being pulled back now, but they are only looking at the short-term, and once the current panic is over I can see such targets being reinstated. In fact, the current consensus is still tipping BT shares as a pretty strong ‘Buy’ right now.
Solid outlook
In the long term, it’s fundamental valuation that matters, and in that I think BT scores highly. There is an earnings dip on the cards for the year ending March 2017, but a couple of years of single-figure rises to follow would put the P/E ratio around 11.
That’s too low, in my view, especially as BT looks set to hand out dividends that are forecast to reach yields of nearly 6% by 2019. Maybe some investors are scared the cash handouts will be cut, but I don’t see it — they’re well covered by earnings, BT is strongly cash generative, and the accounting scandal will hardly affect the cash the firm has available for its progressive payments.
What would the shares look like at 400p? We’d be seeing forward P/E levels of around 14, pretty much bang on the FTSE 100 average. At that price, dividend yields would be closer to 4.5%, which is above average and on the higher side of BT’s longer term trend.
I wouldn’t sell
We’ve had slight downgrades to forecasts, but assuming there are no significant further adjustments, at 400p I’d still see BT shares as a good-value long-term investment. So at their currently depressed 323p price today I think it would be a mistake to keep on dumping — I definitely see shares that are worth hanging on to.
I’m not alone in that thought, as BT directors have been buying heavily since the price crashed last month — in fact, directors and their families have snapped up shares worth close to £600,000 in the past few weeks.
I reckon 400p within a year is definitely feasible, for an upside of better than 20%.
