Trading on one of the lowest earnings multiples of all FTSE 100 companies, whilst being one of the index’s highest yielding companies, now is an opportune time to add this unloved blue chip stock to your portfolio for capital appreciation and income.
BT is the UK’s largest provider of fixed-voice and broadband services for consumers, with a number of divisions including Openreach, which owns and maintains the telephone wires, ducts, cabinets and exchanges that connect almost all homes and businesses in the UK to the national broadband and telephone network.
It also owns EE, the largest mobile network operator in the UK, which has in the region of 30 million customers, and which is also the largest operator of 4G services in Europe. Furthermore, BT also supplies information and communication technology services to 5,500 multinationals across 180 countries.
Fallen Out Of Favour
BT shares have fallen out of favour with investors. At the start of 2016 they flirted with 500p, but have since almost halved to their current level of 262p. There are a number of reasons for the poor performing share price, including the c.£8 - £10 billion pension deficit, which has affected the group’s overall credit rating, but which the group is working to reduce.
There have also been accounting irregularities at its Italian subsidiary, BT Italia, whilst £225 million in warranty payments were made to Deutsche Telekom and Orange, from whom BT acquired EE in January 2016. Meanwhile, in March 2017, the telecom regulator, Ofcom, fined BT £42 million for lowering compensation payments to other telecoms providers for late installation. As a result, BT is preparing to make a £300 million one-off compensation payment to affected rivals.
Finally, in its first quarter results to 30 June 2017, its pre-tax profit was down by 42% to £418 million, as a result of the warranty payment and a £52 million restructuring charge.
With a number of disappointments, it is no wonder the shares have performed poorly over the past two years. However, at the same time, the depressed share price has created an opportunity for investors.
The opportunity exists with BT because the market is factoring in the known negative news, and not pricing in any upside, or more favourable decisions that could positively impact its earnings.
For example, the European telecom services team at Barclays has taken a closer look at Openreach’s regulated prices, and the cost of payments to service providers for connection delays. Barclays believes that the £300 million one-off compensation payment could be too high, and that a more likely figure is £150 million.
Meanwhile, on the pension fund deficit, Barclays notes press reports that suggest BT is preparing to close its defined benefit scheme for existing employees, which accounts for just over 10% of the pension plan’s 300,000 strong membership. Barclays states “This would likely not change the total size of the deficit but would likely reduce annual service costs and cap liabilities.”
These two developments would have a positive effect on BT’s future earnings, and might justify a higher earnings multiple than the current 9.66 the stock trades on.
A Healthy Dividend
The forecast dividend is 15.77p per share for the year ended 31 March 2018, equating to a yield of 6%. For the following financial year to 31 March 2019, the dividend is forecast to rise to 16.22p/share, which is a yield of 6.19%.
BT has a stated progressive dividend policy in place, whereby it aims to increase the payout to shareholders each financial year.
BT represents an interesting opportunity for investors who are looking for a healthy yield from a blue chip stock on a low earnings multiple. Positive news from BT could see the market value the Group on a higher multiple. If the stock were to trade on a 2018 forward multiple of 14, that would imply a share price of 390p, a gain of almost 50% on the current share price. With a 6% yield and trading on a low earnings multiple, BT shares are worth buying for capital appreciation and yield.
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