BT Group: The directors are piling in..
10th July 2020
Share price: 108.6p stg
The share price chart for BT Group is unequivocally bearish. The trend has been downward for some time. There was a failed breakout in late 2018, but the 150 day simple moving average has trended resolutely downward since then.
The shares have lost a whopping 45% of their value since the beginning of 2020, and it is easy to understand why. There has been no growth in earnings in the past few years, and the group is saddled with high debt and a large pension deficit. On top of that, it has a regulator, Ofcom, to contend with. Little wonder then that there was mass dumping of shares, following BT’s cancellation of the final dividend for the accounting year ending 31st March 2020, and the cancellation of both the interim and final dividends for the year ending 31st March 2021. In addition, BT said it could not issue any earnings guidance for the current year.
However, following the above announcement on May 5th, there was very significant share buying by the directors just a few weeks later around the 105p to 110p level. The chief executive, Mr Philip Jansen, bought 1.834 million shares on May 13th for a cost of just over £2 million. Also, the chairman, Mr Jan Du Plessis, bought 500,000 shares for £530,000 around the same time. Some smaller purchases were made by most of the other directors.
So what is going on? An examination of the annual report for the year ended 31st March 2020, reveals some interesting information.
Firstly, the pension deficit has greatly reduced from £7.2 billion to £1.1 billion. This resulted mostly from an accounting change; BT was permitted by the pensions regulator to apply a higher discount rate to future liabilities during the year. It really does highlight how many key assumptions are made in estimating pension fund deficits (or surpluses), but nevertheless, better for the projected deficit to be reduced rather than increased.
Secondly, although BT is not experiencing any growth in earnings, it is generating very healthy cash flow. In the year ended 31st March 2020, it generated an impressive £6.2 billion in cash flow from operating activities. Of this, it invested £4.1 billion in plant and equipment (see details below), thereby resulting in net cash generated of £2.1 billion. This is reasonable similar to the cash flow figure for the previous two years. The current market capitalisation at £10.7 billion is only about five times this annual cash flow, however, one has to add back the very high debt figure to get a true picture. The total debt at the year end was £19.25 billion, deduct cash held of £6.64 billion, gives net debt of £19.25 billion. Add that to the market capitalisation of £10.7 billion, gives an enterprise value of £29.95 billion, which is almost 15 times annual cash flow. Not cheap, but nowhere near stretching the balance sheet in terms of financing this debt.
Thirdly, what is BT investing around £4 billion a year in? It is mostly in upgrading a fibre optic cable network that will be required for 5G, which will mean faster broadband speeds for households and businesses. It does look like this network will become more valuable given the likely trend to more home working, as a result of the pandemic. BT charges other telecom operators for using the ‘final mile’ of this network, but is regulated by Ofcom in terms of the prices it is allowed to levy. However, BT has made reasonably favourable comment in the recent annual report about Ofcom’s understanding of its need to make a reasonable return on this heavy investment.
Fourthly, the accounting policies look quite conservative. There is a hefty charge each year the “depreciation of plant and machinery”. I bet if they were a US company based in Palo Alto, they would probably be capitalising all of this expenditure as infrastructure investment and writing nothing off each year! Despite these big write downs, the net profit margin was a reasonable 8% of turnover, and the P/E ratio a modest 6.2 times, for the year ended 31st March 2020.
Finally, BT is the most ‘woke’ company you are likely to find. The annual report has plenty of stuff about the gender pay gap, diversity, the environment, the stakeholders, the welfare of employees (it is heavily unionised). There is even something in there about the ratio of director remuneration to the average employee salary. It should be in a position to benefit from the big rise recently in so called ‘ESG’ investing, noted by the broadcaster CNBC today. What is ‘ESG’? It stands for Environment, Social & Governance. More and more investors are becoming attracted to these types of funds, so BT could benefit from same.
The most crucial outcome for BT shareholders, however, will be the return of dividend payments for the year ended 31st March 2022. BT is not only promising that dividend payments will resume in that year, it is also giving a specific amount: 7.7p per share, which represents 7% of the current share price.
With both the chief executive and chairman backing up the above promise with significant share purchases for their own account, it could transpire that new investors at the current 109p price level (in pursuit of delayed gratification, being dividends from 2022 onwards) could well be the ‘smart money’ and all of those income funds that were forced to bale out due to the recent dividend cancellation, the ‘dumb money’!
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Although I generally frown on trying to buy at the bottom, that being contrary to most technical analysis techniques; the strong cash flow and directors buying make this a rare candidate as an exception to that rule.