It’s an uncomfortable time to be a shareholder in the UK telecoms giant
Thursday 21 Nov 2019 Author: Steven Frazer

If BT (BT.A) investors thought the dividend was a headache, they are probably nursing a migraine now. A pledge by Labour’s Shadow Chancellor John McDonnell last week to take BT’s broadband national infrastructure backbone Openreach into public hands really did come out of the blue.

The market has been aware of Labour’s plans to renationalise various UK assets, energy and water utilities, but an attack on BT had not previously been on Labour’s hit list. Even BT’s chief executive Philip Jansen admitted his surprise at the announcement.

There are many barriers for Labour to overcome before it could renationalise such businesses, such as funding the deals. A tax on big technology companies be seen as a vote winner but implementing such a scheme will not be easy, nor will striking a deal to the satisfaction of the taxpayer and shareholders without blowing apart Britain’s reputation as a safe place to invest for overseas capital.

Labour is estimating the cost of its BT policy at £20bn which includes £5bn of public subsidy already earmarked for rural network. Yet BT’s boss Jansen told the BBC that including lost revenues from having free broadband nationwide would probably double that bill.

Then there’s the huge pension scheme issue. BT has previously highlighted pension costs as a material obstacle to a potential Openreach demerger while analysts at investment bank Jefferies believe that the BT pension scheme trustee would ‘logically demand very substantial upfront compensation’.

Labour’s capacity to get in at Number 10 with enough of a majority to action many of its more controversial policies is perhaps the biggest challenge to renationalising Openreach.

NEW AND OLD WORRIES FOR INVESTORS

BT’s share price has held up remarkably well since last week’s announcement, drifting just 2% lower to 191.38p. This demonstrates that investors believe Labour has little chance of getting in at Number 10.

However, this isn’t a reason to ignore the situation. ‘There is a risk that Labour’s idea proves popular with voters and other parties feel compelled to move at least some way in this direction’, warns AJ Bell’s investment director Russ Mould.

Analysts at investment bank Berenberg believe BT could face being politically leaned on by a re-elected Boris Johnson, increasingly the political risk, ‘even in the event of a Conservative victory’.

This leaves investors facing another risk to the already difficult juggling act BT must perform to balance its broadband expansion capital investment, meet borrowing costs, fund its pension scheme and retain an income for shareholders from shrinking cash flows.

BT remains a company with little or no growth so income is the key reason to consider the shares. It was therefore disappointing for investors when it cut the half-year dividend in November 2018.

Chief executive Philip Jansen, who took over from previous boss Gavin Patterson in February 2019, retained the full-year dividend at 15.4p per share and pledged to do the same in the current financial year.

A 15.4p per share dividend costs BT around £1.5bn a year and there is reasonable amount of cash flow generated from operations to pay this shareholder reward even after key expenses, such as tax, interest on debt and capital investment are met.

But the margin for error is getting tighter and if profits do come under severe pressure then the dividend could come under threat once again.

STRATEGIC DIVIDEND MOVE?

A tactical cut to dividends, perhaps 20% or 25%, would make a lot of sense. The market already appears to be pricing in a potential cut given how the shares are currently trading on an 8% prospective yield. A stock yielding more than 6% is normally the market’s way of saying it doesn’t believe dividend expectations are achievable.

Analysts are already expecting cuts from 2021, as illustrated by forecasts in the accompanying table.

A dividend cut would save the company around £400m a year which could be used to speed up its network investment plans while providing a larger buffer against weakening trading.

Such a move would also send regulator Ofcom a message that the company is willing to be flexible in meeting the various demands of all stakeholders, playing its part in developing a faster broadband network for the nation while giving investors a return on capital.

Finally, it would draw a line under an issue that has dogged the company’s investment case for several years, namely provide some certainty over the future dividend policy.

‘We think it would be the right thing to do to take some dividend off the table, potentially a 30% to 40% cut, and reinvest that money into Openreach,’ says Adrian Gosden, head of Strategic UK Equities at fund manager GAM. ‘That would bring a whole new raft of people to the story and you’d still get a 5% yield.’

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