Shares in BT (LSE: BT.A) registered their biggest one-day decline in history yesterday after the company issued a profit warning thanks to larger than expected writedowns from its Italy division.
The company is now expected to book a writedown of £530m after discovering that the accounting scandal at its Italian business is bigger than first thought. In an attempt to get all of the bad news out in one go, BT also revealed yesterday that normalised free cash flow for 2016/17 is expected to come in at £2.5bn, compared with a forecast of between £3.1bn and £3.2bn. And revenue isn’t expected to grow for the next two years.
Problem markets
Weak public sector and international corporate markets are apparently to blame for BT’s problems. But these two divisions only account for around 10% of earnings before interest tax depreciation and amortisation according to City analysts. Italy only accounts for a measly 1% of group EBITDA.
BT’s problems seem to be grabbing all the headlines but considering the troublesome divisions only account for a combined 11% of EBITDA, it looks as if the market has overreacted significantly to yesterday’s profit warning.
Indeed, the group’s consumer segment, which accounts for 30% of EBITDA is apparently experiencing positive growth trends. The press release also mentioned that recently acquired EE is experiencing positive revenue growth and fibre broadband connections will reach a new high this quarter.
Downgrades
According to analysts at Morgan Stanley, following yesterday’s update from BT, it’s likely the City will downgrade consensus EBITDA figures by 3% to 5% for this fiscal year. Free cash flow forecasts are expected to be slashed by 12% to 21%.
However, excluding Italy, the figures look much better. For example, stripping out Italy’s costs, the estimated reduction in full-year EBITDA is 1% to 2% and the expected reduction in free cash flow is 6% to 7%.
These figures indicate that the 20% decline in the value of BT’s shares yesterday may be overdone. Of course, other clouds are hanging over the company such as ongoing regulatory and pension issues, which management will have to address. But despite these issues, management is confident enough about the company’s outlook to maintain its commitment to 10% per annum dividend increases.
Dividend looks safe
Even considering the lower cash flow guidance, BT’s dividend payout still looks well covered. Free cash flow of £2.1bn is forecast for the year to March 2018 after deducting pension payments and restructuring costs. The dividend is expected to consume £1.7bn, leaving headroom of £400m. The City has pencilled-in a per-share dividend payout of 16.95p for the year to 31 March 2018, which gives a dividend yield of 5.6% at current prices.
Unfortunately, up-to-date City earnings per share estimates for 2016 aren’t available as BT is expected to report its results for the fiscal third quarter on Friday. If the positive trends in BT’s consumer division that management mentioned in yesterday’s trading update show through in these results, the shares could re-rate sharply higher especially considering the scale of yesterday’s sell-off.
Overall, it looks as if that sell-off was overdone and shares in BT may now offer value.