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Tempted by BT’s share price and dividend yield? Here’s what you need to know

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At a glance, BT (LSE: BT.A) shares appear to offer a lot of value. The FTSE 100 stock has fallen approximately 50% in the last three years and, as a result, it now trades on a forward-looking P/E of 9.1, while offering a lofty dividend yield of 6.5%.

However, it’s generally not sensible to rush out and buy a stock just because it’s cheap and sporting a high yield. Often, when a stock is trading cheaply, it means there are some problems under the bonnet. With that in mind, here’s what you need to know about BT shares right now.

Dividend cut

One of the main issues that concerns me with BT is that the group just cut its interim dividend in November. It was only a 5% cut – from 4.85p per share to 4.62p per share – which certainly isn’t drastic, but it doesn’t exactly send a message of confidence about the future.

Management can talk about things such as “positive momentum” and a strategy that is “delivering” all day long. But, in my view, a company’s dividend is the ultimate barometer of financial health and the future outlook. Put simply, a dividend hike suggests that management is confident about the future, whereas a  cut is a bearish signal.

The recent cut also adds uncertainty to the outlook for the final dividend. Currently, City analysts are forecasting a payout of 15.1p per share for the year ending 31 March, down slightly on last year’s payout of 15.4p. Yet I certainly wouldn’t assume this estimated payout is guaranteed, especially with a new CEO coming in on 1 February, who may have some different ideas about the way capital is allocated. If you’re buying BT shares now, I think you should be prepared for another dividend cut.

Debt pile and pension

One reason the new CEO could decide to lower the dividend is to direct cash towards the company’s huge debt pile. Net debt stood at nearly £12bn at the end of September, which is a large amount for a company of BT’s size. If interest rates were to continue rising and debt-servicing costs increased, profitability could be impacted. This certainly adds risk to the investment case. Furthermore, there’s the group’s sizeable pension deficit to consider. Cutting the dividend (which last year cost the group around £1.5bn) could help the company get this debt and pension deficit under control.

Brexit

Finally, don’t forget Brexit – there are a number of ways this could impact BT. For example, a hit to consumer confidence could affect the group’s ability to hike prices, which would derail growth plans. A no-deal Brexit could also see BT lose lucrative EU contracts, which would mean a hit to revenue. A chaotic exit from the EU could also mean lower interest rates, which would have the effect of further inflating BT’s pension deficit.

So, overall, there’s a lot of uncertainty in relation to the investment case for BT at the moment. As such, I’m avoiding the stock for now. The shares look cheap, but I think there are better dividend stocks in the FTSE 100 at present.

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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.