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BT Group - Italy undermines steady consumer business

Equity research team | 27 January 2017 | A A A
BT Group - Italy undermines steady consumer business

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BT Group plc Ordinary 5p

Sell: 134.50 | Buy: 134.60 | Change -1.05 (-0.77%)
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Adjusting for the acquisition of EE, BT saw revenues decline 1.5% in the third quarter, with earnings per share down 24%. The fall is largely a result of adjustments made in the group's Italian business following the discovery of irregular accounting practices in the division.

The shares remained broadly unmoved following the announcement.

Our View

There is something of a split developing at BT, with the consumer division racing ahead while the divisions serving the public sector and other businesses splutter.

The good news is the group has done a neat job in the consumer facing businesses, transforming itself from a broadband and fixed line business into a provider of 'quad-play' of services by adding mobile through the acquisition of EE and a decent TV package, which includes Premier League football.

Offering customers Premier League and Champions League games at no extra cost has worked out nicely for the group. Since BT TV is packaged together with BT Broadband, the group has been able to rapidly grow its customer base and has enjoyed the lion's share of new broadband additions in recent times.

With a vast fixed line customer base already in place, the final piece in the jigsaw was the mobile market, and the acquisition of EE gives BT market leadership. With the realistic prospect of bundling all four services together, customer churn could decrease. This would support revenue and earnings visibility, and provide significant cash flows.

However, with the problems of improper accounting in Italy and a material slowdown in the Business and Public Sector division, much of the good work is being undone in real time. These issues, combined with BT's substantial debt obligations, mean it's debatable whether any extra cash generated by the consumer business will be returned to shareholders.

BT is aiming to grow the dividend by at least 10% this year and next, and the shares currently offer a prospective yield of 5.6% in FY 2017/18. However, net debt and the pension deficit both stand at over £9.5bn. With more cash likely to be needed to plug the pension shortfall after a review of the funding position later this year, pressure on free cash flow is only likely to increase.

Third Quarter Results:

The group has taken a £245m charge in relation to the irregularities in the Italian business, which has contributed to a 69% fall in earnings in the Global Services division. Previous years' profits have been adjusted by £268m too. However, operating performance elsewhere in the business is looking more positive.

EE added 276,000 net new pay monthly customers, with churn (the percentage of customers leaving BT) of just 1.1%. Retail broadband added 83,000 net new customers, with retail fibre broadband seeing 260,000 net new additions.

BT says that the outlook for its public sector and international corporate division is looking more challenging. The Openreach business has added 498,000 connections to its fibre broadband network, of which 48% are from third party service providers.

Full year guidance has been revised, with the group now expecting underlying revenue to be broadly flat in 2016/17, with EBITDA of £7.6bn and normalised free cash flow of £2.5bn. Revenues and EBITDA will remain flat in 2017/18, with free cash flow moving upwards to £3bn-£3.2bn.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.