In this edition of the Nest Egg Portfolio, we will have another look at BT Group (BT), which still seems to be under pressure. We are still waiting for the company’s full-year results, which should be out in a few months, but let’s use its 9M overview to keep our fingers on the pulse.
BT Group’s 9M results aren’t that bad!
I have been a relatively loyal shareholder of BT Group over the past few years, as I hold stock in my personal portfolio as well as this Nest Egg mock portfolio. For the past several years, I have maintained my view the company’s generous dividend is safe, but that doesn’t mean there aren’t any other/better things to spend its cash on, as BT Group was fighting the perception of very high retirement liabilities on its balance sheet.
(Source: Yahoo Finance)
The first nine months of the year indicate everything is on track
Unfortunately, BT Group doesn’t provide detailed financial results on a quarterly basis, and shareholders will have to be satisfied with full financial statements just twice per year. That’s a pity for a company with a market capitalization of several billions of pounds and being one of the most recognizable brands in the UK.
The third quarter of the financial year (which is the fourth quarter of the calendar year, as BT Group’s financial year ends in March) was a bit tough for the company, as it saw its revenue decrease by 1% to 5.98B GBP, while the margins were further reduced as the EBITDA decreased by 3% to 1.88B GBP despite a 15% EBITDA increase in the consumer segment. The main culprit for the EBITDA decrease was the Openreach segment, where the EBITDA fell by 144M GBP, and this completely compensated the strong performance in the consumer division.
(Source: BT Group press release 31st January, 2019)
Consumer was pretty strong, as BT Group hiked its prices in September 2018, and it does look like the price hikes are flowing almost entirely into the EBITDA result: the revenue of the consumer segment increased by 105M GBP, while the EBITDA increased by 85M GBP. This means 81% of the marginal revenue increase was converted into EBITDA, and that’s an excellent result.
The Openreach segment performed poorly due to the mandatory price reductions on the Ethernet and FTTC products, which contributed to the 180M GBP revenue drop. So, a pretty weak quarter for Openracht, as the 19% EBITDA decrease in Q3 was higher than the 11% EBITDA decrease in the first nine months of the year. (Side note: The Openreach EBITDA decreased by just 5.5% in the first semester of BT’s financial year, so the 19% EBITDA drop in Q3 is quite remarkable.)
On a 9M basis, BT Group’s revenue came in at 17.6B (down 1%), while the EBITDA result actually increased by 0.2%, indicating the EBITDA margin in the first nine months of the year actually increased despite the weak third quarter. BT Group mentions the restructuring-related cost savings as main contributor to the EBITDA margin improvement.
Unfortunately, BT Group didn’t provide a detailed operating cash flow result, but through reverse-engineering, we can clearly see the cash flows appeared to be trending up (although there’s the usual caveat this may have been caused by changes in the working capital position and/or deferred taxes, so I’m not trying to read too much into it):
(Source: BT Group press release Jan 31 2019)
So, despite a 239M GBP increase in the capex, the normalized free cash flow decreased by just 11% to 1.737B GBP, indicating the normalized FCF in 9M 2018 was 1.95B GBP. Combining the free cash flow and capital expenditures, we can calculate the operating cash flow: 4.52B GBP in 9M 2018 and 4.55B GBP in 9M FY 2019.
This confirms BT Group’s financial situation isn’t too bad at all, as the company appears to be able to keep the operating cash flow unchanged, while the higher capex was caused by a higher investment in FTTP (almost 1M premises have now been connected) and the higher take-up rate of BT Group’s Broadband Deliver UK product, which should ultimately result in higher revenue and EBITDA results further down the line.
The dividend should be safe
With a full-year dividend of 15.4 pence per share and a share count of almost 10B, BT Group’s normalized free cash flow in the first nine months of the financial year is already sufficient to cover the dividend.
I still think the net debt (11.1B GBP) and retirement liabilities (5B GBP) deserve more attention, as the combination of both liabilities totals just over 16B GBP, but with BT Group being on track for an EBITDA of in excess of 7B GBP (actually, the company has been guiding for an EBITDA result "around the top end of our guidance"), the leverage ratio (net debt + pension liabilities) remains very acceptable at just over 2. This doesn’t mean I wouldn’t like to see a further reduction of the net debt, as retiring debt will result in lower interest expenses and better borrowing terms for the remaining net debt.
I understand why BT Group doesn’t want to cut its dividend, and looking at the cash flows, there also is no reason for the company to cut it, as the coverage ratio remains comfortably above 100%. Sure, it could make more sense to cut the dividend to be more aggressive on the debt retirement front (or covering the pension liabilities), but there is no urgent need to do so.
And that’s why I am still holding BT Group in the Nest Egg Portfolio. The dividend yield is very attractive, and I’m not worried about a dividend cut. Should the company "rebase" its dividend, it will do so because it wants to reduce its net debt. And that’s perfectly fine with me, as the lower interest expenses will ultimately benefit shareholders, as the free cash flow result will increase. But for now, I’m satisfied with the fully covered 7% dividend yield.
This article was written and submitted before the March option expiration date, but it looks like the Klépierre (OTCPK:KLPEF) put option and the Wereldhave (OTC:WRDEF) call option will expire out of the money, while we bought more time by rolling over the Michelin (OTCPK:MGDDF, OTCPK:MGDDY) for an additional month for net proceeds of 184 EUR.
Regarding Wereldhave, I think the current valuation isn’t doing the company any justice. Yes, the dividend will very likely have to be cut next year, but the balance sheet has also improved after the sale of the Finnish mall. I am writing 1P 24 September 2019 for an option premium of 1.75 EUR. The net cash inflow of this transaction after taking the transaction expenses into account is 172 EUR. I am also adding 40 shares at Monday’s closing price of 24.60 EUR, for a total cost of 1004 EUR, to take advantage of the sub-25 EUR share price. I will soon publish an article to provide a more in-depth explanation of my reasons to do so. The net cash outflow related to both transactions is 832 EUR.
(Source: Interactive Brokers)
After an excellent first quarter, the share price of Orange Belgium (OTC:MBSRF, OTC:MBSRY) seems to be taking a pause now. As we may need to come up with 10,000 EUR to cover the Michelin put option in April, I am becoming a bit more cautious, and I am writing 2 Call options with a strike price of 18 EUR, expiring in September for an option price of 0.79 EUR (the midpoint between bid and ask). The total net cash inflow related to this transaction is 152 EUR.
(Source: Interactive Brokers)
I still consider the National Bank of Belgium (OTC:BQNBF) an excellent proxy on the bond market, but after the recent announcements by the ECB which flagged a serious delay in normalizing the interest rates, I am holding off on buying an additional share in the Nest Egg Portfolio. The national bank usually reports its financial results at the end of March, so I will be looking forward to the dividend announcement (which will very likely be 10-20% lower than last year’s dividend). Should the market be surprised by the dividend cut, I may add an additional share to the portfolio, but only at the right price (around the 2,200 EUR level seems to be fair).
As I explained in a previous article, Eurocommercial Properties (OTC:EUCMF) could be an interesting buy, on the condition that the company continues to strengthen its balance sheet. I am adding 70 shares at Monday’s closing price of 25.12 EUR. The net cash outflow related to this transaction is 1778 EUR, and this increases the position in Eurocommercial to 200 shares.
To avoid being over-exposed to real estate, I am selling the position in LXi REIT (OTCPK:LXILF) at Monday’s closing price of 123.5 pence. Using the GBP/EUR exchange rate of 1.17, the corresponding value is 1.45 EUR per share, for a gain of 16% (excluding the dividends). Selling 2,500 shares results in an incoming cash flow of 3605 EUR, and this creates additional liquidity, while it avoids the Nest Egg Portfolio becoming overexposed to real estate. We did receive the 1.375 pence dividend on March 8th.
Quite a few trades, but I feel the portfolio is now in a better position.
The dividend season will start in a few weeks, but some dividends have already hit the portfolio.
The current portfolio + updates
Noteworthy Europe-focused articles and recent news from Europe
Before putting some other Seeking Alpha authors in the spotlight, I would like to invite you to start following the Focus on Europe series, organized by Seeking Alpha. In every weekly edition, there’s one larger feature article zooming in on an un[der]followed European stock, followed by some brief notes on European companies that were in the news in the previous week.
I will keep the focus on other authors short this week, as we have a lot of information (trades, options, incoming dividends) to absorb, but there are two articles that deserve to be highlighted.
Dhierin Bechai is Seeking Alpha’s own Sherlock Holmes, and he grilled both Airbus (OTCPK:EADSF) and Emirates about whether a certain order for the Airbus A380 was a firm order or just an MOU. Bechai did receive answers from both parties, but doesn’t seem to be impressed with their levels of transparency.
In the UK, Blue Sky Capital has a look at Schroders (OTCPK:SHNWF), a London-listed asset manager. Blue Sky calls Schroder a "best-of-breed UK Asset manager" and expects the company to resume its growth pattern after 2019, as Schroders should start to see the impact of the IT cost savings. Meanwhile, the almost 6% dividend yield is a very attractive sweetener, although the current Brexit uncertainty may make investors wary of investing in the UK until the political crisis has been solved.
I’m pretty satisfied we were able to sell a UK-focused REIT at a handsome profit, which allows us to add to the positions of other REITs that haven’t been performing as well, without increasing the exposure to the REIT sector as a whole.
The dividend season will start next month, and I’m looking forward to cashing in a few thousand euros of dividends, which could help to bankroll initiating new positions or to average down and/or strengthen existing positions in the Nest Egg Portfolio. As almost every company has already published its full-year results, you can expect some more updates over the next few weeks, but I don’t anticipate to see any major changes in the portfolio.
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Disclosure: I am/we are long BT, BPOSF, BQNBF, EUCMF, WRDEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.