The market was full of optimism about the prospects for BT (LSE: BT-A) following its acquisition of EE in early 2016. The share price was touching 500p and the market capitalisation was just shy of £50bn.
However, investor sentiment towards the FTSE 100 group has been badly eroded since. As I’m writing, the shares are trading at a new multi-year low of 188.5p and the market capitalisation is down to £18.7bn.
The question now is whether the company can recover from this slump, and whether the share price can ever return to 500p — a potential upside of 165% from the current level.
Unique position in the market
BT has so far failed to really exploit what I think should be a significant competitive advantage. Its acquisition of EE made it the only UK telecoms group that owns both fixed-line and wireless networks. In theory, this should give it a distinct edge. In the words of one analyst: “As the owner of both networks, it controls the upgrade schedule, so it knows what areas will first be built out with new services, whether that is fibre-to-the-home, G.fast, or 5G.”
In addition, its scale, cross-selling opportunities and potential for increased customer retention, should also be positive for growth and profitability. However, three years on from the EE acquisition, the group’s only managed to achieve modest benefits from its unique position in the market.
Tailor-made
Clearly, many investors have become disillusioned about the company’s prospects. The shares are trading at just 7.7 times forecast earnings per share (EPS) of 24.5p for the current financial year. And the multiple drops to 7.4 next year on forecasts of 4% EPS growth to 25.5p.
This could prove incredibly cheap, if BT does indeed have a competitive advantage and is able to exploit it in the coming years. I think the advantage is real enough, and I also think there’s a good chance of new chief executive Philip Jansen successfully exploiting it.
BT poached him from payment processing company Worldpay where he built a reputation for managing change, and identifying where the business needed to invest to deliver strong profitable growth. He looks tailor-made for BT to me. But has the company got the balance sheet and cash flows to support bold investment?
Return to 500p?
At the end of last year, net debt stood at £11bn, and there was also a £7.2bn pension deficit. Net debt would actually have been half as high again under a new accounting rule that comes in this year, so the balance sheet is stretched.
Meanwhile, management has guided on free cash flow (FCF) for the current year of between £1.9bn and £2.1bn. FCF is the amount of cash left over after all essential costs (including servicing the debt and pension). The company’s vowed to maintain this year’s dividend at 15.4p (an 8.2% yield at the current share price). This will knock around £1.5bn from FCF, which doesn’t leave a huge amount for investment.
However, the company has the option to lower the dividend in favour of investing for future growth, and I do suspect the payout will be rebased next year, just as Vodafone did this year. It may take some time for BT’s share price to get back to 500p, but I think the prospects are promising. I rate the stock a ‘buy’.
