August wasn’t a good month for investors in BT (LSE: BT-A). The shares fell 14%, compared with a 5% decline in the FTSE 100. In this article, I’ll discuss why the share price slumped, and the company’s current valuation and prospects.
Let’s start by summarising the key features of the month:
- Shares ended July at 193.2p.
- 2 August — Q1 results (share price down 3.3% on day to 186.7p, and continued to trend lower in subsequent weeks).
- 23 August — UBS analysts maintained ‘neutral’ rating on stock, but slashed target price to 165p from 240p (shares ended day at new multi-year low of 158.9p).
- Price recovered a little to end month at 165.6p.
Results
BT’s Q1 numbers actually came in ahead of the consensus forecast of City analysts. Revenue dipped 1% to £5.63bn, marginally ahead of expectations of £5.59bn, and there was a 4% beat on adjusted earnings before interest, taxes, depreciation and amortisation (EBITDA). This edged down from £1.98bn to £1.96bn versus expectations of a drop to £1.89bn.
If the performance was better than expected, why has the market responded so negatively? I think there are a number of factors.
Uncertainties
BT’s wholesale Openreach business was largely responsible for the Q1 beat. However, the performance of Consumer was below expectations. The company said on the conference call that the consumer market is “significantly more competitive and aggressive than last year.”
Analysts at Morgan Stanley, who described the conference call as “subdued,” noted that “management acknowledged that the business still faces significant uncertainties ahead.”
I think one of the biggest uncertainties weighing on market sentiment right now is how the company intends to fund its investment plans, particularly with it having indicated it could roll out fibre faster than previously expected. Management has vowed to hold the dividend for this year and next at 15.4p, but with this giving a yield of 9.2% at the current share price, the market is clearly pricing in a dividend cut to help fund investment.
Bargain basement
My Foolish colleague Royston Wild slated BT’s Q1 performance and prospects. He said if he owned shares, he’d sell them without delay. In the short term that’s been a good call, but I’m more optimistic about the longer-term outlook, particularly at the current valuation.
The shares are trading at a bargain-basement 6.9 times this year’s forecast earnings. I expect the dividend to be cut at some point, and would welcome it. For example, a rebasing of the annual 15.4p payout to 10p would free up £500m for investment, and still give buyers of the shares today a handsome yield of 6%.
Chief executive Philip Jansen only joined the company in January. He made his name by highly effective capital allocation for growth at Worldpay, and I think as we get more concrete details on his plans for BT, market sentiment will improve.
Right now, the market and many analysts (including the aforementioned UBS, which slashed its target price in August) appear to see a lack of catalysts for a near-term re-rating of the shares. However, with Jansen’s record at Worldpay, and BT having competitive advantages it’s yet to fully exploit, I rate the shares a ‘buy’ for the long term.
