Troubled BT has further to fall

Dealing with so many problems would be hard enough for a small and nimble company, but BT is a lumbering giant with six subsidiaries and a presence across 180 countries. Its size and public legacy (BT was privatised in 1984 when the government began selling its shares to investors) have also created uncomfortably big pension obligations. In September 2017, the group carried a £7.7bn pension deficit, equivalent to 34 per cent of the current market value, and that's in addition to net debt of £9.5bn. The underfunded defined-benefit scheme has been a big drain on cash: in the 2017 financial year, BT made ordinary contributions of £303m and a further £250m top-up to reduce the deficit. The group is scheduled to make top-up payments every year until 2030 and concerns are growing that the trustees might seek increased contributions to plug the gap in the near term.  

Management is desperately attempting to resolve the pension crisis and recently reached an agreement to close its generous defined-benefit pension scheme for 10,000 managers who joined the company before 2001 (when the scheme was closed). The pension is due for its triennial valuation in June this year and could be helped by the rising bond yields which lower the present value of the liability.

That said, this is certainly not the only drain on BT’s cash. Pressure in the consumer broadband space is mounting and BT has received extensive criticism for not investing enough in the fibre optic network in the UK. In what looks like a bid to punish the company for their lack of investment, Ofcom has proposed to cut the amount Openreach can charge its wholesale customers, which include Sky (SKY) and TalkTalk (TALK). Competition is also rising, with Vodafone (VOD) and CityFibre (CITY) have teamed up to lay their own network of fibre optic cables, starting with the rollout to 1m homes in secondary towns and cities. In the corporate broadband world, BT is being forced to allow competitors to tack their own equipment onto its dark fibre infrastructure, which will also reduce wholesale prices.

And then there is the investment-hungry mobile business. This year Ofcom will auction off some of the wavebands which are expected to be used by 5G (the fifth generation mobile network) that BT’s EE subsidiary is sure to want to bid for. Last time spectrum came up for auction, EE spent £589m.

So, with a lot of costs coming down the tracks, BT’s progressive dividend policy might be difficult to maintain. Forecasts have already been watered down and the dividend is expected at 15.9p per share or £1.6bn, according to broker Numis. This is not covered by forecast free cash flow of £1.3bn. In fact, Numis doesn’t expect the dividend to be covered by free cash flow until after 2020.