Shares in UK telecoms firm BT (BT.) fell last week as it reported third-quarter results that were disappointing. However, Morningstar equity analysts are maintaining a 370p per share fair value estimate and narrow-moat rating, which means it has a slender competitive advantage. We believe the shares are undervalued - the shares are currently trading around 240p.
The firm reported that quarterly revenue fell 3% year on year and is now down 1% for the nine-month period versus our full-year projection of flat revenue. The biggest problem continues to be the global services division. Whereas we've been modelling a significant reduction in revenue in the UK, we had expected the US and Asia to grow in the second half of the financial year, but instead they continue to see revenue contraction as well. We think global services will continue to struggle, but to a smaller degree in the 2019 financial year, and we don’t expect a return to revenue growth until the 2021 financial year.
The retail division has been the primary source of revenue growth for the past couple of years, but was flat in the quarter. We are pleased to see the firm announce that all of its subscribers to BT Sport are now paying something for its service as one of our big concerns had been how BT monetises its investment in sports rights when it gives the service away to its broadband subscribers. BT’s profit margin was also a bit light at 30.5%, but the fourth quarter – its forthcoming set of results – is usually the strongest of the year, which should bring it closer to our full-year projection of 31.5%.
Risks to BT: Brexit, Competition, Regulation
The effects of Brexit could push the economy into a recession and could cause people to reconsider the importance of top-of-the-line bundles of phone and internet access services that BT has been pushing. The recent accounting issues in Italy show that the firm can still be aggressive in accounting for its enterprise business contracts, and there could yet be more restatements needed. On top of all that, the UK remains one of the most competitive markets in the world, with more than 100 firms offering telecom or internet access services. Virgin Media now offers internet access at speeds faster than anything BT can offer in scale.
The firm needs to invest in its next-generation network in order to compete. Also, the European telecom regulator could implement policy changes that could hurt the firm. BT increased its dividend in each of the past five fiscal years and has stated its intention of increasing it further, which would reduce cash available for further debt reduction. The firm is further increasing spending of £960 million for three more years of Premier League Football in a market that Amazon (AMZN) is expected to enter.