BT Group: busy ringing the changes

BT remains busy ringing the changes and there are signals that the optimism which has followed the company more recently is becoming increasingly justified.

A year into her tenure, CEO Allison Kirkby’s transformation plans to cut costs, boost efficiency and provide more focus have been at the centre of the group’s recent fortunes. By the same token, changing horses midstream is never an easy task, and the telecoms sector is a tough place to be in normal circumstances, let alone when a group is in the midst of a turnaround as competitors continue to flourish.

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The interim results in November came with some disappointment, as the group saw a revenue decline which exceeded estimates and resulted in guidance for the full year being scaled back. BT Group (LSE:BT.A)’s particular thorn in the side of late has been the Business division, where weaker sales have been a feature of the group’s recent updates, with particular headwinds coming from overseas.

In the latest quarter, adjusted revenue for the division fell by 2% to £1.9 billion, leading to a decline of 5% in the year to date. There was a glint of optimism with the group having signed a contract with the Home Office, which should add £1.3 billion over the next seven years, but even larger factors are at play.

Given that Business accounts for 38% of overall revenues, the decline is impactful and the group total revenue for the quarter dropped by 3% to £5.18 billion, with the Consumer business also reporting a 2% fall. Consumer is especially vulnerable to the competitive retail environment, although more positively the group reported that Consumer service revenue returned to growth in the period, albeit at a marginal level of 0.4% which compared to a 1.3% decline in the first half of the year.

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The Openreach division, by contrast, has been doing much of the heavy lifting in the meantime and is seen by many as being a future potential jewel in the crown. Following another record build rate of over a million FTTP (fibre to the premises) connections in the latest quarter, Openreach has now reached 17 million premises, more than half of those in the UK. It also leaves the plan of increasing the number by 4.2 million this year and by 25 million in total by December 2026 well on track.

Perhaps equally importantly is the fact that peak capital expenditure on this roll-out is believed to have passed, which is an important inflection point. Indeed, all things being equal this should free up substantial amounts of capital in due course which, given the group’s strong levels of cash generation, can be steered towards what is still an uncomfortably high level of net debt and a pension deficit which has been something of an albatross around the neck for some considerable time. BT estimates that this year’s expected £1.5 billion of cash flow will grow to £2 billion by 2027 and to £3 billion by the end of the decade.

In the meantime, investors are being paid to wait since a healthy dividend yield of 5.5% is more than comfortably covered by earnings, as the company continues to spin its various financial plates. Quite apart from the potential benefits of peak expenditure having passed on the roll-out, BT is bearing down on costs generally as part of the efficiency drive, highlighting improvements in the quarter for both labour resources and repair volumes.

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The update is a stark reminder that the recovery will be a marathon rather than a sprint. A marginally improved pre-tax profit of £427 million for the quarter and guidance being maintained for the year as a whole formed part of what was a generally upbeat release. However, any progress came against low expectations, quarterly revenue estimates were missed once more and there is widespread agreement that further obstacles will present themselves along the way, all of which contributed to a weaker open in early exchanges.

There has been some relief in terms of a share price, which has risen by 28% over the last year, as compared to a gain of 11.6% for the wider FTSE 100, although on a three-year view the shares remain down by 26%. Nonetheless, the general view is defiantly optimistic given the group’s increasing levels of cash generation and prospects longer term, with the market consensus of the shares as a buy likely to remain intact.