BT Group (LSE: BT-A) has dominated the headlines recently after issuing a profit warning in late January. The telecommunications giant informed investors that an investigation into improper accounting practices in its Italian business revealed that the problems were far greater than previously identified and that a writedown of around £530m would be required. Compounding this, the company also noted that the outlook for UK public sector and international corporate markets had “deteriorated” and that earnings would be lower than previously advised.
BT shares fell from 380p to just over 300p on the news, and the question now is whether the company is the bargain of the century or an investor trap. Here’s a few points that might help you make that decision.
Analyst sentiment
Despite the profit warning, sell-side analyst sentiment towards BT Group is still largely positive. Indeed, across 25 brokers surveyed on Bloomberg, 14 rate the company as a ‘buy’, nine as a ‘hold’ and only two suggest selling the stock. There’s also some lofty price targets among the brokers, with analysts at Barclays, Bernstein and Societe Generale setting price targets of 475p, 390p and 415p respectively.
Dividend commitment
Another argument for the bull case is the fact that BT Group plans to continue growing its dividend by “at least 10% in both 2016/17 and 2017/18.” With the company paying out 14p per share in dividends last year, that would take the next two yearly payments to 15.4p and 16.9p per share. The commitment to the dividend hike signals a level of confidence from management, and if the company does follow through with the increase then shareholders are looking at a prospective yield of 5.5%.
Director purchases
A further signal of confidence is the fact that multiple directors have bought shares in the last few weeks. Directors’ buys can be a useful indicator of the future prospects of a company as those with an inside knowledge of the company are unlikely to spend their hard-earned cash on company shares if they believe the company is going downhill. In BT’s case, around £600,000 of shares have been purchased by directors since the profit warning.
Debt levels
On the bear side, investors should keep BT’s significant debt levels in mind. Indeed, with liabilities of over £30bn on the balance sheet, BT’s liabilities are very large relative to its market capitalisation. Generally speaking, the higher the debt levels of a company, the more risky the investment case, as it increases the chance of the company getting into financial difficulties.
Pension liabilities
The other critical issue is BT’s underfunded pension scheme, which according to analysts at MSCI, is the second worst funded pension scheme in the world. In October, BT reported that its pension deficit had grown to a huge £9.5bn, up from £6.2bn just three months earlier.
Significant pension liabilities can also add an element of risk to an investment case, as the company will often need to direct funds towards the pension to reduce the size of the liability. Given that one potential consequence of this is lower dividends for shareholders, investors should be mindful of BT’s huge pension deficit if looking to invest for the dividends.
So while BT’s dividend yield looks attractive, I’m hesitant to invest, as the debt and pension deficit take the shine off the bull case for me. As such, I’m leaving BT Group on my watch list for now.