Berenberg repeated a ‘buy’ rating on BT but cut its target price to 260p from 310p and downgraded its underlying earnings (EBITDA) and revenue forecasts.
The broker lowered estimates for 2019 and 2020 by 2% and 4% for EBITDA and by 2% and 3% for revenues, respectively. Normalised free cash flow guidance was reduced by 13% for 2019 and by 22% for 2020.
Berenberg said the downgrade to earnings reflects higher operating expenditure expected at the Openreach network arm.
The broker forecasts underlying earnings (EBITDA) to fall to £7.33bn in 2019 from £7.51bn a year ago. EBITDA is expected to be flat in 2020 before rising to £7.47bn in 2021.
“Part of our Buy case was based on a return to EBITDA growth in 2019/20, which we do not now expect until 2020/21: investors will have to be patient,” Berenberg said.
Openreach costs are forecast to rise as BT invests in upgrading the UK’s broadband infrastructure by replacing aging copper lines with fibre optics to improve internet speeds.
BT plans to roll out fibre to three million premises by 2020.
Financials in decline but valuation appears cheap
Berenberg also noted that BT has faced “significant headwinds” in recent years with public sector contracts ending, accounting fraud in Italy, tightening regulation, slowing consumer telecoms pricing and a pension scheme deficit.
“As a result, its financials are now in decline, rather than growing, causing a de-rating,” the broker said.
However, Berenberg added: “BT’s valuation now appears cheap versus peers, while we see a path to the company returning to growth in revenue, EBITDA and normalised FCF in the medium term.”
Investment case clearer
Its investment case is also clearer as the market now knows the outcome of BT’s pension review, the auction for 4G and 5G spectrum, the Premier League auction and Ofcom’s review into the prices Openreach charges broadband providers, Berenberg said.
“Looking ahead, the investment case is now derisked with the only major events in the next 18 months being the government’s Future Telecoms Infrastructure Review, the 700MHz spectrum auction and Ofcom’s Business Connectivity Market review,” it said.
Why did BT hold its dividend?
Earlier this month, BT left its dividend unchanged as it reported a 1% drop in revenue to £23.7bn and a 2% fall in adjusted underlying earnings (EBITDA) to £7.5bn in the year ended March 31, 2018.
“Why did the board decide to keep the dividend at 15.4p for the next two years, given that net debt will now increase by £3bn over this period?,” Berenberg questioned.
“As incoming chairman, Mr (Jan) du Plessis was in no way anchored to the dividend policy and could easily have cut it. By strongly committing to it, he has attached himself to it.”
BT also downgraded its full year EBITDA estimates for 2019, which Berenberg believes was the “biggest shock in the results”.
BT could have issued profit warning sooner, Berenberg suggests
Berenberg asked what could have changed between the third quarter update and the full year results to have not issued its profit warning earlier and avoid any surprises.
“The downgrade relates almost entirely to Openreach”, Berenberg said, adding that the company has pointed to regulatory headwinds for revenues, higher business rates, pay rises, and more resources to reach increasing minimum service levels set by Ofcom.
“However, none of these issues are new and consensus Openreach EBITDA for 2018/19 actually increased by 0.8% after Q2 and by 0.3% after Q3.”
Consumer strategy 'not a game changer'
Last week BT's consumer boss Marc Allera unveiled a new strategy to improve its customer service reputation by offering faster internet speeds, more TV content and bringing its call centres back to Britain and Ireland by 2020.
He said BT, which owns EE and Plusnet, will provide customers with a joint offering of its fixed-line and mobile networks.
Berenberg said it believes the new strategy is "not a game changer".
"The key focus was on price rationality and BT’s plan to win in fixed-mobile convergence through innovation, not discounting," it said.
"We also note that BT intends to stop reporting individual product net adds (eg broadband net adds, TV net adds), which may leave it open to criticism for reduced disclosure."
Shares in BT rose 0.3% to 204p in morning trading.