BT Group (BT.A), the largest telecoms group in the UK, this morning reported a 15% increase of its latest quarter profit to £3 billion, resulting in significant dividend growth.
The company revealed its plan for a 13% increase of the full-year dividend to 14p per share, from 12.4p the year before. It also proposes to raise its dividend by more than 10% in each of the next two financial years, reflecting the company’s “strong overall performance for the year”, according to its chief executive Gavin Patterson.
Part of its outlined plans also includes a £6 billion investment in “ultrafast” broadband and 4G coverages in the UK over the next three years. The company unveiled integration of its acquisition of mobile operator EE, which was cleared by regulators earlier this year, is going well. The stock is rated three-star by Morningstar analysts meaning they consider it fairly valued.
Shares in BT led the FTSE 100 gainers as the market digested the strong earnings result, sending its shares up as much as 3.2% in day trading by 3pm on Thursday. However, the stock is still down 4.4% year to date. Rival Vodafone Group (VOD) slightly gained 0.6% but Sky (SKY) lost 0.5%.
Will Dividend Growth Become a Risk?
BT has increased its dividend in each of the past five fiscal years. While this is positive news to investors compared with the dividend cuts at many other European telecom operators, Morningstar analyst Allan C. Nichols reminded investors that there are underlying risks: the firm slashed its dividend in fiscal 2010 in order to protect cash.
“Dividend growth would reduce cash available for further debt reduction in the company,” Nichols explained, “The firm is further increasing spending with its bid of £960 million for three more years of Premier League Football and a £12.5 billion offer for EE, which will return it to owning its own wireless network. While these deals make strategic sense, they increase execution risk and will increase the firm's debt.”
In addition, the company’s large and still underfunded pension fund continuously puts the balance sheet at risk as it has to pay £250 million in fiscal 2016 and 2017 under the new pension agreement. Payments will be increased to nearly £700 million annually for the next four years, with continued payments through 2030.
BT’s Acquisition of EE
The acquisitions of EE in February 2016 turns BT into the only truly convergent telecom operator in the UK according to Nichols, with the ability to offer fixed-line telephony, broadband, pay TV and wireless telephony on its own network.
The U.K. has trailed several other European countries in moving to converged services, but analysts think this acquisition will help to jump-start that move. BT should benefit, as it controls the whole network, while others will need to wholesale at least some services from somebody else. BT's best-performing division has been its consumer sector, and the addition of EE should help this business even further.
Should Investors Eye Telecoms Stocks?
The UK remains one of the most competitive markets in the world, with more than 100 firms offering telecom or Internet access services, with no other network competitor across 40% of the population.
While BT still has a lock on some revenue from a large part of the country, its rival Sky also dominated the pay-TV market in the UK, giving its control over rights to many contents. The UK is Sky's most important market, and continues to perform very well. Despite focusing more on profitability and less on marketing, Sky still added 46,000 new broadband customers in the quarter and 438,000 new products. It also continues to increase its subscriber base even as Netflix adds customers. Additionally, Sky has acquired Sky Italia and Sky Deutschland, providing additional growth opportunities. The stock is rated a three-star fair valued stock by Morningstar analysts.
Another large telecom group Vodafone also did a good job of marketing its faster broadband speeds. The company sold its stake in Verizon Wireless and distributed about 71% of the proceeds to shareholders, leaving it with a stronger balance sheet. This enabled the firm to outspend its competitors in upgrading its network, while still increasing dividends and making acquisitions. Analysts do anticipate its free cash flow covering the dividend again starting in 2017.
Simon Murphy, manager of the Old Mutual UK Equity fund spoke to Morningstar last month, saying telecoms was one defensive area to invest in.
“I think we are starting to see some industry repair in Europe and we're starting to see some price pressure come back in, which is good for the telecoms sector,” Murphy concluded.
