The BT Group (LSE: BT.A) share price has risen by around 25% over the last 12 months. I think this unloved FTSE 100 stock could keep rising, as the firm’s turnaround starts to deliver results.
In this piece I want to explain why I think BT may now be poised to deliver a sustained recovery.
Here’s the problem
In my view, the biggest challenge facing BT boss Philip Jansen is profitability.
BT’s operating profit margin has slumped in recent years, falling from 18% in 2016 to just 12% last year.
What this means in practice is that the money BT spends on network upgrades is not generating as much extra profit as it used to. A good example of this is mobile data.
The price we pay for mobile data has fallen steadily in recent years. But we’re all using more high-speed data than ever before. To support this usage, BT has had to add new data capacity and fund the rollout of its 5G network.
In my view, this is the biggest risk facing shareholders. If BT can’t improve its profitability, then its share price isn’t likely to recover.
City experts forecast recovery
Fortunately, things may be starting to improve. City analysts covering BT think that the changes made by Mr Jansen should deliver a gradual recovery in profit margins. They’re forecasting a gradual improvement in profit margins over the next couple of years.
The latest broker consensus forecasts suggest that BT’s operating margin will rise by 1% by 2024. This may not sound like much, but I estimate this increase could add about 7% to the group’s profits.
Higher profit margins should also improve BT’s cash generation, strengthening support for the dividend. With a 4.3% yield, BT’s income potential is above the FTSE 100 average of 3.3%. As an income investor, that’s of interest to me.
Interest rate rise could fix pension
Another one of BT’s well-known problems is its pension deficit. This was last reported at £5.3bn in September last year.
However, if interest rates start to rise, as many analysts expect, then the pension deficit could start to shrink. The reason for this is that higher interest rates should enable BT’s pension funds to generate more income from their assets. In turn, this reduces the amount of extra cash required to support pension payments.
In my view, rising interest rates would reduce the risk of a future dividend cut to fund pension payments. Good news for shareholders.
BT share price: time to buy?
Of course, BT shares aren’t without risk. The group’s high level of debt and pension obligations mean that if Mr Jansen’s plans disappoint, shareholders could see the share price slump again.
Even so, I think this FTSE 100 stock looks attractive at the moment. BT shares currently trade on just nine times forecast earnings, with a 4.3% dividend yield. That looks good value to me.
My sums suggest that if BT can deliver a modest improvement to profit margins, its shares could re-rate to a higher valuation. That could lead to some decent share price gains over the long term, plus an attractive passive income.
I’d be happy to add BT shares to my long-term portfolio today.