Why I’d shun this FTSE 250 dividend stock and buy the BT share price

Roland Head explains why he’s buying BT Group plc (LON:BT.A) but avoiding this FTSE 250 (INDEXFTSE:MCX) turnaround situation.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares in satellite communications group Inmarsat (LSE: ISAT) were down by 6% at as I wrote this piece, taking the stock’s one-year decline to 30%. Ouch.

This business provides satellite internet services to ships, aircraft and remote locations all over the world. Customers include most major shipping lines, airlines, oil and mining firms and governments.

In terms of service provision, Inmarsat is a market leader. But today’s share price fall doesn’t surprise me. Today’s half-year accounts confirm my view that shareholders in the group continue to face significant financial risks.

Sales up, profits down

One highlight of today’s figures was that revenue for the last six months rose by 4.9% to $717.2m, compared to the same period last year. The company said that the majority of this growth came from the aviation sector, where many airlines are adding in-flight internet services to their aircraft.

Unfortunately this increase in sales wasn’t enough to support profits. Earnings before interest, tax, depreciation and amortisation (EBITDA) fell by 1.8% to $373m. The main reason for this appears to be $31.7m of extra spending on “low-margin equipment” to help capture further market share in this sector.

This suggests to me that new airline customers may be driving a hard bargain. There’s more satellite capacity than there used to be, so potential customers can afford to be choosy.

This extra spending also highlights the capital-intensive nature of the firm’s business. Inmarsat must continually invest in new equipment to maintain and improve its services. Capital spending totalled $257.8m during the first half of the year. Although this was lower than during H1 2017, it still accounted for more than one third of revenue.

Debt problems scare me

This is a profitable, market-leading business that provides good services. But in my view it has too much debt.

Net debt rose from $2,078.6m to $2,139.5m during the first half. That represents almost three times the company’s EBITDA from the last 12 months. That’s well above my preferred maximum of two times EBITDA.

The dividend has already been cut by 63%, falling from 54 cents per share in 2016 to a guided level of 20 cents per share for the current year. I think there’s a risk that this payout could be cut again.

Unless market conditions improve, I suspect Inmarsat will need to raise fresh cash by selling new shares at some point over the next few years.

One way around this problem would be for the firm to attract a trade buyer. But a recent move by French firm Eutelsat Communications failed to result in a bid, presumably because the parties couldn’t agree a price.

Not cheap enough for me

Inmarsat’s earnings have been falling steadily. This is expected to continue:

Year

Adjusted earnings per share

2016

$0.65

2017

$0.42

2018 (forecast)

$0.38

2019 (forecast)

$0.21

These forecasts put the stock on a 2018 forecast P/E of 19, rising to a P/E of 34 in 2019. Although the 2.9% dividend yield is reasonably attractive, I don’t think the shares are cheap enough to reflect the risks posed by the group’s high debt levels.

I share my colleague Rupert Hargreaves’ view that this stock is one to avoid.

I’m buying BT

I’ve been buying shares in telecoms giant BT Group (LSE: BT-A) this year. Although this FTSE 100 firm does face some challenges, I think it could be a good turnaround buy.

July’s first-quarter trading update showed that adjusted pre-tax profit rose by 3% to £816m during the first half. This improvement seems to have been driven by the group’s consumer business, where sales rose by 2% during the period and EBITDA profit rose by 10%.

BT says that this improvement was driven by growth in sales of expensive smartphones, and SIM-only mobile contracts, along with an increase in the number of customers now paying for the BT Sport television service. Operating costs stayed flat during the period, allowing the increase in revenue to flow straight through to profits.

A turnaround with legs?

Chief executive Gavin Patterson will be leaving the building later this year. Chairman Jan du Plessis took soundings from shareholders and decided that “a change of leadership” was needed to deliver Mr Patterson’s turnaround strategy.

I can’t help but agree. My view is that the CEO has been too distracted by BT Sport and has been slow to protect the group’s operating margin, which has fallen from 17.8% in 2014 to 13.3% last year. The company so far failed to take advantage of its scale, as the owner of the UK’s largest mobile and fixed broadband networks.

The good news is that Mr Patterson’s turnaround strategy should address all of these problems.

The new BT Plus service provides seamless high-speed internet across mobile and fibre broadband connections. And the £800m cost-cutting programme should deliver annual savings of £1.5bn after three years.

Jobs are being cut in some areas and added elsewhere. And the company has now agreed a pension deficit reduction programme that provides visibility on payments until June 2020.

Why I’m buying

These developments are all good news for BT shareholders, in my view. But there were two other factors that swung the decision and persuaded me to buy the shares.

The first was the appointment of City veteran Mr du Plessis as chairman. This South African businessman has an impressive track record of turning around big companies. Most recently he led miner Rio Tinto from 2009 until 2018.

The second factor was that I thought the shares were starting to look too cheap. Even in its present condition, BT is expected to generate normalised free cash flow of between £2.3bn and £2.5bn this year. That values the shares at roughly 10 times free cash flow, which looks tempting to me.

Income investors will probably be tempted by the 6.6% yield that’s currently on offer. Personally I think there’s a good chance this payout will be cut by Mr Patterson’s replacement, to help fund pension payments and debt reduction.

But with the shares trading on just 8.8 times forecast earnings, I still think BT is too cheap to ignore.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of BT and Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »