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Thinking of buying BT shares? Here’s what you need to know

BT (LSE: BT.A) shares look cheap right now. The telecommunication giant’s share price has fallen all the way from around 500p in early 2016 to just 224p today, a decline of 55%, and at present the stock trades on a forward-looking P/E ratio of 8.6 and sports a gigantic dividend yield of 6.9%. However, if you’re considering buying BT shares because they look cheap, there are several things you need to know.

Revenue is declining

For starters, BT’s top line is expected to fall this year. For the year ended 31 March 2018, it generated revenue of £23,746m, down from £24,082m the previous year. This year, analysts expect sales to fall further, to £23,332m, representing a decline of nearly 2%. This downward trend in sales is not what you want to see as an investor.

Profits are falling

Similarly, earnings per share (EPS) are also expected to drop this year. Last time, the group generated EPS of 27.9p. However, this year, analysts expect EPS of 26.1, a decline of 6%, followed by a further fall to 25.6p next year. Again, the trend here is concerning.

Analyst downgrades

What’s even more worrying is that City analysts are still downgrading their earnings forecasts for BT. In the last month, analysts have downgraded their earnings estimates for this year by 0.19p per share. Over three months, consensus earnings estimates have fallen by 1.21p. That’s not good news for shareholders as earnings downgrades can hurt a company’s share price.

Debt is sky high

Investors also need to be aware that BT is carrying an awful lot of debt on its balance sheet right now, as well as a huge pension deficit, which adds considerable risk to the investment case. At the end of June, net debt was £11.2bn. Given that total equity on the group’s balance sheet was £10.3bn at 31 March, BT has a high debt-to-equity ratio. Interest coverage (EBIT divided by interest expense) was only six times last year, which doesn’t leave a huge margin of safety. Then there’s the pension deficit as well, which at 31 March was £11.3bn. It is going to require payments of £2.1bn over the three years to March 2020 and the issuance of more debt to reduce the deficit.

Dividend sustainability

Combine the group’s declining revenue and profits with the high levels of debt and the massive pension deficit, and the outlook for BT’s dividend looks uncertain. The fact that the yield is nearly 7% would suggest that many investors have their doubts about the sustainability of BT’s payout. Last year, the company held it steady at 15.4p per share, but will it be able to pay the same dividend this year with the extra pension payments that are required? Analysts are becoming more bearish on the group’s dividend prospects, with the consensus dividend estimate for this year having fallen by 0.7p per share over the last three months to 15.2p per share.

Conclusion

Weighing all of this up, the outlook for BT shares looks uncertain. They do look cheap at current levels, but investors should be aware of the risks.

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Edward Sheldon has no position in any shares mentioned. 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.