Inflation will help BT squeeze more from its assets

Inflation-linked price rises and cost cutting across the business have helped BT (BT) squeeze more profit out of its customers, and the under-pressure telecoms company is now forecasting to be at the top end of its full-year normalised free cash flow forecast.

In the medium term inflation might prove to be a tailwind. Initially, rising commodity and energy prices increased the significant capital expenditure (capex) costs of expanding its fibre optic network, which caused normalised free cash flow to drop.

However, now energy and commodity prices are falling so are BT’s capex costs. In the six months to September this year, capex was down 11 per cent to £2.3bn due to lower build unit costs. But this hasn’t slowed down the rollout, with Openreach adding a record 860,000 premises to its fibre optic network last quarter.

The other side of this equation is that revenue is rising because of the CPI-linked contracts. Openreach average revenue per customer grew 10 per cent year on year. This was down to a combination of price rises and an increased number of customers switching from copper to the more expensive fast fibre optic. Openreach revenue rose 8 per cent while its cash profit (Ebitda) was up 12 per cent.

The good thing for BT investors is that while energy prices and commodity prices can come down, its contract prices don’t. Lower capex but fixed higher rate contracts is good for cash flow. Management expects normalised free cash flow to rise to “at least” £1.5bn by the end of the decade. Brokers are a little more confident than this, with FactSet consensus expecting free cash flow of £2.1bn by 2028.

This all needs to be understood, though, in the context that the company is not growing. Revenue was flat year on year which given the price rises means it is losing customers. The Openreach broadband base was down 255,000 due to a “weaker broadband market”. Customers have been switching away in areas where BT can’t yet offer fibre optic. To keep these customers onboard, it will need to rollout faster, but this won’t happen soon given the challenge of managing its costs.

This profit growth also came about while keeping staff costs flat. BT isn't going to grow rapidly but it is going to be able to squeeze more cash out of Openreach when its own costs start falling. The company offers a 7 per cent forward dividend yield, and remains the cheapest telecoms company in Europe on an enterprise value to Ebit measure. We stick to buy.

Last IC View: Buy, 136p, 18 May 2023