BT shares are popular with many investors. It’s a market leader in a safe, steady industry which is relatively insulated from economic turbulence. Most of the time, that’s the sort of thing I go for as well. Safe, steady companies, preferably with high yields and high returns without high risks.
So when a subscriber recently asked me for my opinion on BT, I thought I’d crunch some numbers to see how the shares stand up under closer scrutiny.
1. If you’re looking for a solid track record of growth, you won’t find it here
The first thing I like to see in a company is an upward trend in revenues, earnings and dividends over time. I don’t like to rely on investor sentiment to make money in the stock market; I prefer to invest in growing companies so that an increase in the share price is almost inevitable.
Alas, I was somewhat disappointed in BT’s longer-term track record, which you can see below.
Even ignoring the somewhat depressing 2009 figures, things aren’t looking good for BT. The results today are essentially where they were many years ago. That’s not exactly a stellar growth story, so it may be somewhat optimistic to assume high rates of growth in the future. This means that strategy number 1 (picking companies with long histories of consistent growth) goes out of the window.
2. The price-to-earnings ratio is nothing special
If you can’t reasonably assume high rates of future growth, a second backup strategy is a share price re-rating. This sometimes happens when a company’s shares are very cheap relative to earnings, perhaps because of some short-term bad news which, given enough time, will pass.
The PE ratio today is around 12.3, which as most experienced investors will tell you, is nothing more than okay. In fact, it may be less than okay, given that the company shows no signs of reliable growth.
However, I prefer to look at today’s share price relative to the average earnings over the last ten years. This can give a more consistent indication of a true value investment, and value investments are often the ones that get re-rated upward.
BT’s 10-year earnings average figure comes out at 17.2p, which gives a price to 10-year earnings average figure of 12.7. That’s not bad – in fact, it’s lower than the equivalent figure for the FTSE 100, which is currently at 13.3. However, the FTSE 100 does show a fairly consistent upward trend in earnings and, therefore, probably does deserve to have a small premium in its PE rating.
This means that if you’re looking for a company with a low valuation, BT may not be it.
3. Income investors may not be impressed
A third source of returns is the trusty old dividend. Or perhaps not so trusty in BT’s case. As you can see in the chart above, the dividend took a hefty cut in 2009 in order to make it more sustainable going forward.
The yield today is around 3.8% which is just about the same as the FTSE 100’s yield. One advantage for BT is that the latest annual report suggests that the dividend is set to grow by 10% to 15% a year over the next three years. Whether or not that turns out to be the case is another matter.
If dividends do grow by 15% a year, then they would go from 8.3p today to 12.6p in 2015. 12.6p is higher than the average full-year payment of the last decade and is higher than any other payment in that time other than the unsustainably high amounts paid out in 2007 and 2008.
Even if growth is only set at 10% a year, then the dividend is still set to grow to 11p, which is still above the average of the last decade.
Are management being over-optimistic in their goals for the dividend?
Let’s be generous and say that the dividend does grow at 15% a year in the next 3 years, all the way up to 12.6p. What yield does that give at today’s price of 221p? It comes out at a somewhat attractive 5.7%, which sounds nice on the face of it… if it can be achieved.
On the other hand, Vodafone, a company with a very good track record of growing dividends year after year, has a yield of 5.2% today and is, therefore, less reliant on spectacular dividend growth in the future (although it may still produce it).
So once again, if you’re looking for high-yield shares, BT may not be the best place to look.
4. Large debts can be a real drag
By now, I would usually have given up my analysis. With little or no long-term growth, a mediocre PE and an average yield, BT is not exactly an obvious bargain. But in the name of thoroughness, I’ll carry on, although the general picture doesn’t get any happier.
One of the big threats to any company is the size of its debts. In this case, BT’s debt interest payments are covered by earnings just 4.4 times over. That’s very low, even for a supposedly non-cyclical business like BT. It means that interest payments (£484 million) are eating up cash. It means that shareholders are at risk of a rights issue or worse if the interest payments can’t be met or if the debt can’t be rolled over in a sustainable fashion.
None of this is good news.
5. Giant pension obligations are not good either
Other than interest-bearing debts, there are some other ‘obligation’ based factors that can negatively affect a company. One of them is lease payments, and another is pension plans and their related deficits.
BT has one of the UK’s largest pension schemes, and it has a multi-billion pound funding deficit to go with it. Much like interest-bearing debts, this is another black hole into which shareholder’s cash can disappear in alarming amounts, year after year. That means saying goodbye to cash that could have either been profitably reinvested for future growth or returned to shareholders as a dividend.
Is there a silver lining?
Perhaps it’s not all bad. The valuation isn’t excessive – you only have to look back to 1999, when the shared traded for more than 1,000p, to see what a really daft valuation looks like. And the company is very likely to still be around in five or ten years, unlike many others.
But when I look at BT, I see a company and an investment that screams mediocrity, and mediocrity has rarely been a winning investment strategy.