Openreach is starting to come good but BT can do more to make shareholders better off. The shares look very cheap.
BT shares have been decidedly lacklustre after a brief period of takeover speculation in the summer. There have been concerns that the company’s key asset – Openreach – could be upstaged by the likes of Virgin Media and Comcast owned Sky in the race to connect Britain’s homes and businesses to ultrafast internet known as fibre to the premises or FTTP for short.
Thursday’s half year results from BT were very reassuring on this issue. Openreach is performing quite nicely, In fact, it is the only part of BT that is currently showing any revenue growth. However, as it is the biggest source of profit growth for BT as a whole, that is a good sign as profits were up by 7 per cent.
There are a number of developments that look quite bullish for Openreach and BT.
Firstly, it has decided to take on and fund the roll out of FTTP to 25 million homes by 2025 by itself. It had been considering a joint venture. This means that it can capture the whole value of FTTP investment.
Secondly, the cost of connecting premises is coming down from £300-400 to £250-£350. This is reducing BT’s peak capital investment from £5bn a year in 2023 to £4.8bn which is a nice little boost to its free cash flow.
Thirdly, ten communications companies including Sky and Talk Talk have signed up to Openreach’s long-term FTTP pricing. This underpins demand for the FTTP product where BT is allowed to charge prices that will give it a very fair return on its investment and one that is much better than other network operators in areas such as water and electricity are currently getting.
With billions of pounds to be invested, this gives Openreach an opportunity to build its asset value as well as its revenues and profits.
When combined with the EE mobile network which continues to roll out its 5G services, BT is building a very compelling converged telecom network of full fibre, WiFi and mobile connectivity that is fit for the future. Virgin and O2 will try to do the same but it is also going to cost them a lot of money. There is increasing doubt whether new entrants into this market will have the money to build a network that can compete.
Elsewhere, it is encouraging to see that BT’s customer churn rate remains very low in its Consumer business at around 1 per cent. It also continues to take broadband market share which is now 54 per cent up from 50 per cent a year ago.
Things look like they are shaping up quite well for BT. It has reiterated its profit guidance for 2022 and 2023 and has succeeded in taking costs out of the business at a faster rate than it initially thought. £1.4bn of annual cost savings have been achieved with the company now expecting to reach £2bn over the next couple of years.
With the efficiency of the business getting better and the cost of FTTP investment coming down, BT is bullish on its long-term free cash flow generation potential. It reckons that it can be generating £2.8.bn of annual FCF by the end of the decade compared with £1.1-£1.3bn in the current year to March 2022. This would equate to 20 per cent of the company’s current market capitalisation.
I don’t expect for one minute for investors to base a bull case for BT shares on a 2030 free cash flow yield of 20 per cent but it gives an insight into the FCF growth that can be expected once FTTP investment is finished and the potential this gives the company to grow its dividend payments.
It is also worth noting that this FCF guidance doesn’t take into account any full fibre revenue growth which is very likely.
This is all very encouraging but BT can do more in my view.
BT Sport has looked like a very expensive broadband customer retention strategy for years. Selling it either partially or completely is a good idea in my view. There has been plenty of chatter that DAZN wants to buy it and increased audiences suggest that the product is still popular. The sooner this happens, the better.
Global Services adds very little incremental value to BT and has limited growth potential. It may have synergies with other parts of BT but selling this too and using the proceeds to pay down the still very large £5bn pension deficit would create value by removing a source of worry for investors. I would expect the valuation of the shares to rerate upwards if this happened.
It is also interesting to note that last week BT employed an advisory firm – Robey Warshaw – to help it build a takeover defence. Altice has a 12 per cent stake in BT and is backed by activist Patrick Draghi. It gave a binding commitment not to bid for BT for six months after buying its stake. That commitment runs out on 10th December.
I think BT shares look very cheap despite bouncing strongly on the back of its results. At 150p, the shares trade on a one year rolling forecast PE of just 7.4 times whilst offering a forecast dividend yield of 5 per cent.
BT: Current consensus forecasts
|Free cash flow||1,128.9||1,304.0||1,078.4|
Disclosure: Phil Oakley currently owns shares on BT.