If you’re worried about the falling FTSE 100, spare a thought for BT Group (LSE: BT-A) shareholders.
Although the FTSE 100 has fallen by about 7% over the last month, the BT share price has dropped by 13% over the same period. Since the start of January, BT stock has fallen by a whopping 30%.
Clearly there are problems at the telecoms giant. But this is still a business that makes more than £2bn profit each year. With the shares trading at less than seven times forecast earnings, is it time to look again at BT stock?
Let’s talk about the dividend
BT’s dividend has been unchanged at 15.4p since the 2016/17 financial year. However, the shares have fallen by about 50% since then, which has left the stock with a dividend yield of 9%.
Many people expected new boss Philip Jansen and chairman Jan du Plessis to push through a dividend cut as soon as they took charge of the company. This hasn’t happened. However, I think there are several good reasons to expect a dividend cut at some point.
At the top of the list is the likelihood that the group will have to ramp up spending in order to meet its target of connecting 15m homes to fibre broadband by 2025.
CEO Mr Jansen told shareholders at the group’s annual general meeting that hitting this target would be likely to cost an extra £400m-£600m per year. Mr du Plessis said that one way to fund this spending would be through a dividend cut, “a year or two in the future”.
I expect a cut
This situation highlights BT’s cash-hungry nature. Although the business has historically enjoyed good cash generation, the need for constant investment means that spending is high too. Capital expenditure was £3.7bn last year, compared to a pre-tax profit of just £2.7bn. Net debt rose by £1.3bn to £11bn.
When you look at these numbers, I think it’s fair to say that the group’s £1.5bn annual dividend payment looks hard to afford. I think a cut is likely within the next couple of years.
The good news is that even if the dividend is cut by 40%, BT stock would still offer a solid 5.5% dividend yield at current levels. A lower payout would also strengthen the group’s financial position, paving the way for better returns in the future.
A long-term play?
BT’s adjusted earnings are expected to fall by about 6% this year, before edging higher in 2020/21. Spending won’t fall any time soon and the group’s first-quarter results suggest that profits remain under pressure in all parts of the business.
However, both Mr Jansen and Mr du Plessis are very highly regarded and have considerable experience. I imagine that both men will be very keen to deliver on their promise of a turnaround.
I also think that BT shares are starting to look quite cheap relative to the firm’s historic profits. Last year’s operating profit of £3,421m leaves the stock trading on a debt-adjusted valuation of 8.4 times profits. That doesn’t look expensive to me.
BT shares could have a little further to fall, especially if the UK is in a recession. But with the shares trading on less than seven times forecast earnings, I think a lot of bad news is in the price. I’d say that BT shares are worth watching at this level.
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Roland Head owns shares of BT GROUP PLC ORD 5P. 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.