FTSE 350 Review: The best picks among struggling telecoms stocks

Telecommunications is an expensive business; wires need to be buried and towers erected, and then a few years later the whole process needs to be repeated when the technology of the moment becomes outdated.

And that assumes things go to plan. The expectation was that ultra-fast fibre-optic broadband and 5G infrastructure would be rolled out by 2024, and companies would be seeing the benefits of their investment. However, after a period of high inflation and rising interest rates, companies are instead laying off employees and disposing of underperforming businesses as they look to preserve cash.

In October, Vodafone (VOD) sold its Spanish business for up to €5bn (£4.3bn), saying it is right-sizing “for growth”. This sale follows the disposal of its Vantage Towers, Hungary and Ghana units in previous years. All companies are looking to grow, but a lot of Vodafone’s new cash may go towards the dividend, given it is struggling to cover its €2.5bn annual payout in the absence of disposals. The alternative is a cut to its distribution levels.

Last year, Vodafone’s adjusted free cash flow fell 11 per cent to €4.8bn. However, this adjusted figure doesn’t include licences and spectrum costs, restructuring costs or working capital related items. Equity free cash flow, the amount available to pay out to shareholders, was just €3.1bn, according to broker Numis. The broker had forecast a further fall to €1.9bn this year. This was before the Spanish sale, but there are only so many disposals Vodafone can make.

The other option is job cuts. Last May, new chief executive Margherita Della Valle announced that the company planned to cut 11,000 jobs over the next three years.

Likewise, BT (BT.A) is planning to remove 5,500 jobs by 2030, equivalent to 30 per cent of its workforce. BT is still facing a familiar problem: the rising cost of its Openreach fibre-optic rollout is cutting into its cash flow. In the full year to last March, normalised free cash flow was down 5 per cent year on year “because of increased capital expenditure, primarily in Openreach”.

Cost-cutting at the telecoms providers has been an issue for suppliers such as Spirent Communications (SPT). Its software tests telecommunications infrastructure and demand is dependent on the amount of investment in the network. Traditionally, it has been quite a cyclical business, but there was hope that this time the need to catch up with 5G would smooth out some of this cyclicality.

This has not proved to be the case. Spirent missed its profit guidance multiple times last year, and for the full-year revenue was down 22 per cent. The combination of a drop in orders coupled with inconsistent guidance from the company has contributed to the share price falling almost 50 per cent in the past 12 months.

The silver lining for the industry is that inflation now looks to be easing. In the six months to December, BT’s cash flow came in at £0.5bn, due to a £0.3bn decrease in capital expenditure, as the costs of commodities and energy fell back. Management is now able to guide to the top end of its £1bn-£1.2bn cash flow forecast.  

For  BT and Vodafone, falling costs could free up cash to invest in improving the network, and allow them to shore up customer bases via less punitive price rises. If this proves to be the case, their free cash flow yields of 5-6 per cent don't look too bad.

The flipside is that inflation has not completely gone away yet and supply shocks, as recent events in the Red Sea demonstrate, could still emerge in unexpected areas. This would cause Vodafone and BT to either cut back on dividends, or their infrastructure investment. Either way, it would not be appealing to investors.