I reckon we’re in strange times for the FTSE 100 when BT Group (LSE: BT.A) is offering dividend yields as high as 10%. If you’re looking for income from your investments, you might think that’s one to snap up quick. If you invest £1,000 in a stock with an annual yield of 10%, in five years you’ll have £1,600. And in 10, your pot will have reached £2,600.
So you might expect investors to be buying the shares, which would push the price back up. And that would reduce the dividend yield to around the long-term average.
But exactly the opposite is happening. Investors, rather than snagging themselves an income steam of 10% per year, have instead been on a selling spree. BT shares have slumped 33% over the past 12 months, and by 65% in five years.
The obvious conclusion is that the markets have little confidence in BT’s high dividends, and a look at forecasts confirms that. Analysts are expecting 15.4p per share for the current year, the same as it’s been for the previous three years after the telecoms giant hiked it to that level in 2017. But they’re predicting a fall to around 11p per share next year, for a cut of nearly 30%.
In that, BT is echoing what’s happened to Vodafone before it. For years, Vodafone was offering high yields that weren’t even covered by earnings, and the share price suffered similarly. The company bowed to the inevitable in 2019 and slashed the dividend by 40%. Some people, including me, still think that’s too high and expect further pain for Vodafone shareholders.
I think the same is true of BT. The predicted 11p dividend for next year would give shareholders a yield of 7.2%, and that’s still a terrific annual income. It would, after all, still be enough to double that £1,000 investment in 10 years.
Again, we can only assume investors fear further dividend cuts in the years ahead. I share those fears, and I have to ask two questions. Firstly, why is the BT dividend under pressure?
It’s in a very competitive and developing high-tech market and it needs to invest billions to keep up with technology. BT recorded capital expenditure in the first half of the year of approximately £1.9bn, which suggests £3.8bn per year. Against that, dividends are costing the firm around £1bn per year.
If there’s enough cash to afford that, fine. But at the Q3 stage at 31 December, BT’s net debt stood at a staggering £18.2bn. That’s 64% worse than a year ago, although some of the increase is due to the move to IFRS 16 accounting standards. And BT is still stumping up pension fund deficit payments too.
To put BT’s debt into some kind of perspective, it represents 120% of the company’s entire market capitalisation. So if you buy BT shares, you’re buying more debt than company.
Now to my second question. Why do companies pay such big dividends when they’re shouldering massive debts and really can’t afford them? After scratching my head many times over what I see as inadequate capital management, I still can’t work out a convincing justification. When I see such a dividend/debt situation, I walk away and look elsewhere.
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Alan Oscroft has no position in any of the 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.