Investors have been sceptical about BT’s ability to manage the competing demands on its capital — a weaker guide on the cashflows the company expects to generate this year indicates that caution is well placed.
The telecoms giant is pushing ahead with the rollout of BT Openreach’s full-fibre broadband network, which the FTSE 100 company has said will cost £5 billion, up from £4.8 billion. A tax refund of £200 million will plug some of the extra cost, but not all. The result? Free cashflow, before pension deficit payments, will be at the lower end of the £1.3 billion to £1.5 billion range guided towards this year.
Adjusted profit guidance for the 12 months to the end of March next year has been maintained at a minimum of £7.9 billion. Investors don’t seem to buy it, with the shares falling almost 9 per cent yesterday and sinking back below the 130p-a-share level at which BT made its stock market debut in the 1980s.
An enterprise value of 3.9 times forecast adjusted earnings before taxes and other charges leaves BT almost as cheaply valued as it has been in the past decade. But that reflects the increased pressures on cashflows and heightened risk that it misses even the bottom end of its guidance this financial year. How a rising rate of inflation affects the bottom line is the major unknown.
Annual price increases will help. Openreach increases the charges for providing fixed access broadband and connectivity to other providers in line with consumer price inflation. The price charged to consumers and small and medium-sized businesses also increases each year in line with CPI plus 3.9 per cent. Price rises won’t be enough, anyway. How does BT hope to fend off an even greater rise in energy and labour costs? Squeezing out more costs from the business by 2025 and raising its gross savings target to £3 billion, from the £2.5 billion previously targeted. The group has already cut £1.7 billion from its operating bill, including reducing its office numbers and cutting customer tariffs by almost a third. Now management is looking at making savings in procurement, automating more of the business and reducing headcount. The latter risks inflaming tensions with unions and comes just weeks after strike action by members of the Communications Workers Union over a pay dispute.
Investors might feel more comfortable about BT splurging if broadband customers of Openreach were actually rising. Instead, they declined by 89,000 during the second quarter of this year, with 40,000 attributed to disruption caused by industrial action. The rest? A pull forward of demand during the pandemic; a slowdown in the number of new homes being built; and some consumers eschewing broadband altogether and using their mobile phones for internet access. Either way, the result is the same.
Inflation aside, the competitive pressures facing BT remain. The enterprise division has not managed to stop the slide in the top line, with revenue declining 5 per cent over the six months to the end of September. Large companies are the problem. Large-scale network projects haven’t recovered since the pandemic, but there is also a longer-term shift towards multinational companies eschewing private networks and connecting their global operations through the web. BT is yet to take out the fixed costs associated with work relating to the latter.
A policy to maintain or grow the dividend each year remains and analysts have forecast a full-year payment of 7.79p a share, which leaves the shares offering a potential yield of 6.7 per cent at the current price. In the near-term, it’s difficult to see the shares re-rating without greater reassurance that cashflows can withstand rising inflation and the capex bill.
ADVICE Hold
WHY Pressure on free cashflow could prevent the shares from recovering
Derwent London
Derwent London might have to work harder to convince investors that demand for office space remains as strong as ever. The FTSE 250 constituent let space over the third quarter of the year at an average 27.6 per cent ahead of the estimated rental value at the end of December last year.
But the volume of space let amounted to rent of £1.9 million, which even after adding the £1.1 million generated by space under offer, is much lower than the £5.5 million the landlord secured during the same period last year.
The summer months were quiet, but September viewings have picked up, according to management. The pace at which the commercial landlord, whose portfolio is centred on London’s West End, manages to let its four recently completed developments in the coming months will give investors a better idea of how the prime office market is holding up in the face of a darker economic outlook. On the plus side, only 6 per cent of space is for retail, a sector where occupiers are likely to face greater pressure from a downturn in consumer spending.
The company’s shares have fallen 36 per cent since the start of the year as rising interest rates have stoked expectations that property values will fall to compensate for higher financing costs. Analysts at Numis forecast a net asset value of 3,547p a share at the end of December, down from 3,959p at the same point last year. Investors are braced for a far larger decline, with the shares priced at a 38 per cent discount against the broker’s forecast.
For Derwent, the risk of rising debt costs having any marked impact on its bottom line is low in the short term. All of Derwent’s £1.2 billion debt is at a fixed rate. It has £626 million in cash and undrawn revolving debt facilities on its balance sheet, which means that the company can easily fund the remaining £346 million cost to complete its two committed developments without raising more debt. Capital expenditure this year has been entirely funded via property sales. The caveat? Disposals might not come so easily, which could mean it has to draw on credit at a floating rate.
ADVICE Hold
WHY Steep discount attached to the shares compensates for the risk of a falling NAV
