FTSE 100 telecoms giant BT (BT.) has been downgraded by Morningstar analysts amid concerns over regulatory pressure affecting profit margins. Despite the drop in its fair value estimate from 360p to 320p, the company remains undervalued, according to analyst Michael Hodel, with shares currently trading below 200p after sustained share price weakness in recent years.
“We believe the firm is gradually moving in the right direction, but progress will likely be slow,” he says. BT has been in a strong position as the only “converged” operator offering fixed-line telecoms, broadband and mobile phone services, but the benefits of this position have started to slow as BT has failed to overcome regulatory, operational and competitive challenges.
The most contentious and costly issue for BT in recent years has been its infrastructure business Openreach, which regulator Ofcom forced it to split out from its consumer business in 2017.
As owner of the telecoms infrastructure, BT sells network access to the likes of Sky and Virgin, but Morningstar analysts say the company does not make a profit from this operation. “We expect Ofcom will continue to pressure the prices Openreach charges for network access,” Hodel argues; this is one of the main drivers of the share price downgrade.
Hodel says the cost of running Openreach has dragged on BT’s profits and revenues as well as stalling its upgrade plans. Currently 3 million customer locations (business and residential premises) have access to super-fast broadband, and BT says it can boost this to 15 million by around 2025 if the regulator allows it to make a better return from Openreach. Regulatory pressures on prices at Openreach have “forced BT to constantly cut costs to preserve margins”, Hodel says.
Change at the Top
Under former chief executive Gavin Patterson, BT spent big to build market share in its consumer business, setting up BT Sport to take on Sky Sports and buying the rights to Champions League football in 2013. In 2016, BT bought mobile phone company EE, which in 2012 became the first network to roll out 4G coverage. (Today it is the first network to roll out 5G).
Nevertheless, BT’s share price has struggled in recent years, falling from nearly 500p in 2016 to nearly 200p today. Brexit is expected to hit the company’s European revenues, and the competition among mobile phone providers has intensified. Vodafone (VOD), which has recently cut its dividend by 40%, faces similar pressures. In terms of City brokers, Numis has a share price target for BT of 340p and a buy rating, just above Morningstar’s fair value, while Societe Generale has just reiterated its buy recommendation with a new target price of 320p.
The share price slump has pushed BT’s yield to above 7%, making it ones of the top yielders in the FTSE 100, but there is speculation that BT will be forced to cut its dividend, which last year was unchanged at 15.4p per share.
Chief executive Gavin Patterson left in February and was replaced by Philip Jansen. Investor disquiet over the share price, job cuts, missed profit targets and even the move out of the firm’s HQ for 150 years brought an end to Patterson’s tenure with the firm.
Jansen said this month as BT announced full-year results that “we have a lot of work to do to … deliver long term sustainable value to our shareholders”. Last year’s final results showed a fall of 1% in revenue to £23 billion, and BT expects revenue to fall 2% in this financial year.
