BT Group Analysis

Should you invest in BT Group? 
This blog post is going to use fundamental analysis and information from the BT Group 2015 Annual report to investigate if BT Group is a potential investment.

Background
BT Group plc. is a UK based telecommunications company. It provides telephone products and services, broadband networks and television content. If its proposed EE merger goes ahead it will also provide improved and substantial mobile phone services. It has a current share price of 463.60 and a dividend yield of 2.77%. The share price is +26.15% in 2015.

Current macro environment
The UK economy grew 3% in the 2014, however economic growth is generally sluggish this year compared to last year. Worries about China and uncertainty about when the Fed will raise interest rates has caused some market volatility, BT suggests this is delaying infrastructure upgrades for corporate customers. Moreover fears of a recession occurring over the next year in the US could lead to contagion affecting the UK, dampening BT Group’s share price prospects. With a beta of 1.04 BT Group will be highly susceptible to market movements. In terms of competition the telecommunications market in the UK is dominated with a number of key players including Virgin Media, Vodafone and TalkTalk. BT Group’s potential merger with EE will consolidate its position as the main UK provider of 4g and internet services. In terms of the up-and-coming TV content consumers are changing their preferences towards on-demand content (e.g. Netflix), which could affect BT Group’s TV content strategy.

Annual Report

  • Five Strategic growth areas: fibre, TV and content, mobility and future voice services, UK business markets and supporting leading global companies.
  • Focus on superfast broadband. Current network covers 75% of UK, previous target was set in 2008 at 40%. Success down to Openreach investment.
  • 50% increase in fibre broadband connected homes in 2015.
  • Announced deal to merge with EE (£12.5bn) to release BT Mobile into the consumer market and become largest 4g and internet provider in UK.
  • BT sports acquisition key for television business. Premier league for three more years and extended Premiership rugby rights.

Key performance

  • Consumer revenue +7% due to fibre broadband and TV growth.
  • Customer service ratings +4.7% this year vs. +1.5% last year.
  • Net labour costs improved -8% due to increased productivity across business.
  • Dividend up +14% to 12.4p.
  • BT sports viewing improved +15%. Two million customers subscribed to BT sports, four million if Virgin Media contract included.

Ratios
In this section I will analyse some key accounting ratios for BT Group to provide an overview of its financial conditions. I’ve also included a ratio table for one of its main competitors, Vodafone. Adding another company allows the comparison of ratios and will provide a stronger insight into BT Group’s competitiveness in the market.

BT Group Ratios 2015 2014
Profitability
Operating Profit 19.36% 17.19%
Return on Capital Employed 16.27% 16.48%
Return on Shareholders funds 112.13% 108.79%
Efficiency
Receivables Days 63.75 days 58.02 days
Payables Days 132.82 days 126.81 days
Liquidity
Current Ratio 0.97:1 0.74:1
Acid Test 0.96:1 0.73:1
Gearing 87.34% 93.29%
Interest Cover 3.97 times 3.75 times
Vodafone Ratios 2015 2014
Profitability
Operating Profit 4.66% 7.00%
Return on Capital Employed 1.85% 2.57%
Return on Shareholders funds 104.51% 90.90%
Efficiency
Receivables Days 41.98 days 31.13 days
Payables Days 14.94 days 17.49 days
Liquidity
Current Ratio 0.69:1 0.99:1
Acid Test 0.67:1 0.97:1
Gearing 24.41% 23.93%
Interest Cover 1.13 times 1.73 times

Profitability
BT group is generally a profitable company with an improvement of its net income by 5.79% 2014 to 2015. Its ROCE and operating profit ratios are 19.3% and 16.2% respectively and significantly higher than Vodafone’s 4.6% and 1.8%. This demonstrates an ability to use its capital efficiently and sell goods for more than they cost to make, suggesting good control of production costs. The increase in the operating profit ratio from 17.1% to 19.3% y-y is supported by a 2% decrease in operating costs, as a result of productivity increases and a focus on reducing debt and increasing growth. We are likely to see a rise in operating costs next year as the cost of investment for television content filters through the financials.

Efficiency
The two ratios used to analyse efficiency here are payable and receivable days. Payable days at 132 days and significantly higher than Vodafone’s 14 days. This could be attributable to managerial efficiency, as they secure better contracts and hold onto credit longer before paying it back, in order to help expand the business. However the payable days ratio was calculated using operating costs and not CoGS in the case of BT Group, due to unavailability of a specific CoGS figure in the annual report. This makes the current ratio reading of 132 days unreliable and incomparable to Vodafone. In terms of receivable days BT has 63 days compared to 58 days in the year previous. This indicates consumers are taking longer to pay back BT for extended credit and could show managerial inefficiency, possibly a result of them extending credit to customers who cannot pay. Whilst Vodafone’s figures are shorter it could be an indication that they sell less credit goods.

Liquidity
The current and acid ratios for BT group are both below 1 at 0.97 and 0.96. This indicates current liabilities exceeding current assets, meaning liquidity issues could arise if there is a need to sell assets quickly to pay off liabilities. However the figures are in line with Vodafone, suggesting it is an industry trend and not disadvantageous to BT Group. Furthermore the increase from 0.73 to 0.96 in the acid test from 2014 to 2015 demonstrates a declining use of overdraft facilities, which means debt is being paid off and is being raised elsewhere in more long-term, cheaper and reliable forms. This is backed up by the annual report stating a strong focus on reducing unsustainable debt levels. We also see this in the level of gearing in the company falling from 93% in 2014 to 87% in 2015. These levels are exceptionally high compared to Vodafone and are attributable to the BT group’s pension deficit alongside investment spending on infrastructure (Openreach) and Television content (BT Sports). With an interest cover of 3.97 times the level of gearing is less concerning than Vodafone who only have an interest cover of 1.13. Regardless it is comforting to see a downward trend.

While the ratios seem clear cut, strong conclusions cannot be met by analysing an individual two year period. A further look into the context of the company is required and analysis over several more years would be more reliable. Furthermore a holistic analysis of competitor ratios is required to provide an even more contextual view of BT Group’s individual performance.

The interesting part
Here I look a various valuation methods and provide my own view on a price target.

  • Dividend growth model: Expected to grow between 5-15% yearly. Model would then value BT Group at 620p (Required return on equity = 10% (average historical return), Dividend growth average = 8%, Current dividend = 12.4p).

  • DCF analysis: can provide a stronger insight into valuation based on expected cash flows. Equity research teams will incorporate DCF in their analysis. We can see on HL.com that five out of nine brokers recommend BT Group as a strong buy. The FT.com suggests a median price of 510p over the next 12 months from a larger pool of 19 analysts.


  • EV/EBTIDA: current valuation from Fool.com shows 7.1x vs. peer metrics of 6.3x. Suggests overvaluation of BT group of 14% and target price of 398p.

  • ProdigyMarket View: Providing solid TV content growth and a successful EE merger I would be targeting a bullish case of 600p by 2017. In a less bullish situation I would be eyeing up 480p a share. My main concerns lie with the pension deficit, being revalued in June 2017, and the large investment in television content being able to match revenue growth in this area. A declining gearing ratio (93% to 87%) and a large interest cover (3.97 times) calms my nerves about debt levels and it is good to see management placing an emphasis on debt reduction and growth in their annual report. If the EE merger goes ahead they will be market leaders in 4g and internet provision and they are already tapping into Sky’s monopoly market of television sports. This continued aggressive growth means strong growth from BT over the next few years, providing we don’t see another recession.

N.B Ratios: 

I used operating costs for trade payables, BT did not offer breakdown of CoGS.

For Vodafone I ignored one off impairment costs in 2014. They were large and would have deterred from the ability to compare with BT Group.

I used Capital Employed = shareholder funds+non-current liabilities+short term borrowing

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