The Motley Fool

Is the BT share price a bargain buy or value trap?

The BT (LSE: BT.A) share price looks like an attractive investment at current levels. Shares in the UK’s largest telecommunications company have fallen 30%, excluding dividends, this year and, following this decline, the stock is trading at a forward P/E of just 6.8. A dividend yield of 9.1% is also on offer at the time of writing.

While I’ve advised against buying BT in the past, even I’m attracted to this low valuation. Indeed, it’s one of the lowest ever placed on the stock.

The lowest valuation

To try and understand whether or not the stock is a bargain buy or value trap, we first need to work out why the market is placing such a low value on the shares. The most obvious reason is growth, or rather a lack of growth. The group reported a 1% year-on-year decline in overall revenue for the first quarter and pre-tax profit declined to £642m, from £704m a year earlier, because of higher costs.

These numbers have reinforced City expectations that earnings per share will fall 15% for fiscal 2020. If profits do decline by that number, it will be the 4th year in a row. That deserves a lower-than-average valuation.

Analysts are currently expecting growth to return in the 2021 financial year. It’s difficult to tell at this point if the firm will meet these figures. Analysts are only expecting growth of 3%, but if BT misses this target, it will be the fifth year in a row the company has had to unveil falling returns to shareholders.

Struggling for growth

I’m sceptical the group will be able to return to growth. BT has one of the worst reputations in the telecoms market, particularly among customers. When it dominated the market, this wasn’t a problem but, as competitors have started to take market share, BT’s poor customer service is dragging down returns.

The hundreds of additional job cuts management is planning in an attempt to improve group profitability is unlikely to improve relations with customers. Therefore, I think it’s highly likely customers will continue to flock to competitors, sapping BT’s sales further.

To keep up with competitors, the company is also having to ramp up capital spending. Chief executive Philip Jansen has admitted the business will have to spend £400m-£600m extra a year to meet the firm’s goal of connecting 15m homes to full fibre broadband by the middle of the next decade. A dividend cut has been touted as a solution to freeing up capital for this ambitious target.

The bottom line

So overall, shares in BT might look cheap, but the company’s lack of growth and increasing competition in the UK telecoms market is concerning. The business is going to have to spend more to remain relevant and this may mean the 9% dividend yield is under threat.

With £12bn of net debt, excluding the company’s pension deficit, BT’s balance sheet is also fragile, limiting flexibility. As a result, I think it may be better to watch this one from the sidelines rather than try and take advantage of its low valuation today.

High-Yield Hidden Star?

Discover the name of a Top Income Share with a juicy 7% forecast dividend yield that has got our Motley Fool UK analyst champing at the bit! Find out why he thinks “the stock’s current weakness may offer us the chance to buy a proven dividend performer at what could be a bargain price”. Click here to claim your copy of this special report now — free of charge!

Rupert Hargreaves owns no share 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.