Financial Analysis of BT Group plc.
BT Group is one of the leading European companies providing telecommunication services and equipment.
1.a Appendix 1 gives a summary of BT Group's consolidated balance sheet as on 31 March 2004. The company had £16,068m of fixed assets comprising mainly of tangible assets at £15,487m. BT had very less intangible assets as it had written off most of the goodwill.
The company also had current assets and current liabilities of £10,550m and £8,548m respectively and hence £2,002m of working capital or net current assets. Total assets less current liabilities stands at £18,070m and are being financed through long-term creditors, provisions and shareholders funds.
The company had £12,426m of long-term loan financed through a range of US dollar, Sterling and Euro bonds. The company has also £2,504m of provision for liabilities and charges relating mainly due to deferred taxation (£2,191m). The total book value of shareholders funds is £3,094m. Provision for liabilities and charges has reduced the book value of equity shareholders by lowering profit and loss account. So we can say that provision for liabilities is being financed by internal accruals.
BT Group has £109m of cash at bank and in hand. It also has short term deposits and investments of £3,916m and listed investments of £1,247m. These are as good as cash as they be converted into cash on a short notice. So BT has total cash and cash equivalents of £5,272m. The total short and long term loans and borrowings of £13,697m. Thus BT has net debt of £8,425m (13,697 - 5,272). The net debt to equity gearing ratio is expressed as net debt divided by total shareholders funds.
Debt to equity ratio = 8425/3094 = 272%
This means that debt finances almost three times assets as being financed by equity. Higher debt means that the weighted average cost of capital is low as cost of debt is lower than cost of equity. But as BT reduces more debt, its weighted average cost of capital will increase. The increase would be partially slightly offset by lower cost of equity due to lower chances of bankruptcy.
1.b Appendix 2 shows the main elements of consolidated cash flow statement
BT Group is generating high amounts of cash inflow from operating activities. During the year ended 31 March 2004, the company generated £5,392m of net cash from operating activities. BT is in telecommunication business which demands relatively high level of absolute investments. Even after incurring £2,477m of capital expenditure, BT was left with £2,017m of surplus cash. The company also sold net short term investments of £1,123m, leaving it with £2,489m of cash before financing.
The company has used cash generated above primarily to repay loans. BT has reduced loans by £2,301m. If BT would not have reduced its debt, then its net debt would have been £10,726m. BT is trying to reduce its debt over the years. BT's operations are generating surplus cash which it is finding it difficult to employ into high return projects. Few years back there was also concern about BT's high level of debt. So now BT is trying to reassure markets by reducing its high debt.
1.c Telecommunication is a very capital intensive business. BT had built its business by taking large amounts of loans over the years. The business model is such that it has high fixed costs and low variable costs. Like most of other high fixed costs businesses, BT faced tough times when the competition reduced prices as variable costs are less. During 2001 and 2002, BT's operating profits declined while its interest payments increased. This had a very negative impact on its share price.
BT also sold its mobile operations. Now a day major investment in telecommunication services is in mobile telecommunication only. The non-mobile business doesn't need that high level of frequent investments. BT's profile has now changed from a growth company to a mature cash generating company.
The lack of right investment opportunities and decision to enhance creditors and shareholders confidence has resulted in retirement of debt. In 2004, BT paid net interest of £941m and its operating profit before goodwill amortisation was £2,892.
Depreciation was £2,921m.
EBITDA = £2,892 + £2,921m = £5,813m
Interest cover ratio = Earning before interest, taxation, depreciation and amortisation / net interest
Interest cover ratio = 5813/941 = 6.18
BT generated earnings more than six times net interest payments. This shows that its debt levels are now very much within manageable levels and is more like a cash rich mature company.
2.a Earnings per share Appendix 3 gives the earnings per share in the last five years. The basic earnings per share have fluctuated a lot in the last five years from a high of 31.2p in 2003 to a low of -25.7p in the year 2001.
To analyse earning per share, it is better to first start with basic earning before goodwill amortisation and exceptional items. Appendix 3 also shows the basic earning per share before goodwill amortisation and exceptional items. As can be seen from the table, operating profits for the company have not fluctuated like basic earnings with the highest and lowest operating profits being £3,772m and £2,580m respectively in the five year period upto 2004 (BT, 2004).
The variation in basic earnings, post tax, results from £3 billion plus goodwill amortisation and exceptional items in 2001 and 2002. Additionally, year 2002 earnings benefited from £4 billion plus gain on sale of fixed assets and investments. These are non-recurring events and so earnings before goodwill amortisation and exceptional items should be taken more as representing the underlying business going forward.
2.b Five year dividend policy Appendix 4 shows the five-year dividend history of the BT Group. In the five year period from 2000 to 2004, dividend decreased in the first three years and then increased in the last two years. In the first three years, dividend decreased 90% from 19.6p to 2.0p.
Appendix 4 also shows the dividend payout ratio. The formula used for dividend payout ratio is
Dividend payout ratio = Dividend / Earning before goodwill amortisation and exceptional items
The % decrease in the payout ratio was more than the % decrease in earnings before goodwill amortisation and exceptional items. The ratio initially declined from 66% to 33% before rising again to 50% in 2004. Normally companies don't like to change dividend if they feel that decline in earnings is only for a short period. The rapid initial decline shows that, going forward, the company wasn't sure about its earning potential.
Companies normally have a dividend policy and most of the companies follow a constant increase policy. BT's has now adopted a different policy of centring on dividend payout ratio. BT's policy is to increase dividend payout ratio to be around 60% for the financial year 2006 (BT, 2004). 60% is a very high number. It shows that the company doesn't have much capital intensive growth plans relative to its size, its business has stabilised and it is more like a mature company.
Constant payout ratio as opposed to constant dividend growth policy implicitly conveys that the company is not very sure of its ability to increase earnings each year. Yet the company also doesn't see a threat to the fundamental business and can easily repay its commitments. This is also evident from the high amount of loans retired in the last three years.
2.c PE ratio BT Group's price to earning ratio, as taken from Financial Times, was 12.2 on 15th March 2005 (Financial Times). This multiple is based on a share price of 200 p and an earning per share of 16.4 p.
Price to earning ratio = Share price / Basic earning per share = 200 / 16.4 = 12.2
Price to earning ratio of 12.2 signifies the mature nature of the business. The average earning per share over the last five yeas was 12.3p, which results in a price to earning ratio of 16.3.
BT's price to earning ratio with respect to last year's earning is near market average but on the lower side. Even the price to earning ratio based on last five year's average is not high. Higher price to earning ratio are mostly associated with growing companies or companies undergoing turnarounds. BT doesn't fall into either of the two categories.
Another way to analyse a company's life stage is to look at its dividend yield.
Dividend yield = Dividend / share price
On 2004 dividend of 8.5p, the dividend yield is 4.25%. The average dividend over the last five years was 8.7p, which translates to a dividend yield of 4.35% at current share price of 200p. The below average price to earning ratios and high dividend yields reflects market opinion that BT is more like a mature company with steady or modestly growing earnings.
2.d It is difficult to compare BT Group's PE ratio with that of the sector based on the last years basic earning per shares. Most of the companies in the FTSE Telecom sector incurred losses in the last year due to goodwill amortisation and exceptional items.
BT Group, going forward, has a slightly lower PE ratio than the sector. This is because most of the other companies in the Telecom sector are expected to show a turnaround this year. BT's earnings are now more or less stabilised. Also most of the other companies are smaller and hence have a potential to grow faster.
Vodafone and O2 are comparable in market size to BT but both are in mobile telecommunication, a business still not as mature as landline communication. They both have higher progressive PE ratio as compared to BT reflecting the growth potential in their earnings.
Appendix 1: Summary consolidated balance sheet of BT Group plc
£m 31-Mar-04 31-Mar-03 Fixed Assets 16,068 16,661
Current Assets 10,550 11,556
Creditors amount due within one year
Borrowings 1,271 2,548 Other creditors 7,277 7,132
8,548 9,680
Net Current Assets/(Liabilities) 2,002 1,876
Total assets less current liabilities 18,070 18,537
Creditors amount due after one year
Borrowings 12,426 13,456 Total creditors due after one year 12,426 13,456
Minority Interest 46 63
Provisions for liabilities and charges
Deferred taxation 2,191 2,017 Other 313 359 Total provisions for liabilities and charges 2,504 2,376
Total Equity Shareholders interests 3,094 2,642
Source: BT Group Annual Report 2004, http://www.btplc.com/Sharesandperformance/Howwehavedone/Financialreports/Annualreports/AnnualReports.htm Appendix 2: Summary consolidated cash flow statement
£m
2004 Net cash inflow from operating activities 5,392 Net cash outflow from return on investments -527 Taxation -317 Net cash outflow from capital expenditure -2,477 Net cash inflow before acquistions and disposals 2,071 Net cash inflow from acquistions and disposals -60 Equity dividends paid -645 Net cash inflow before financing 1,366 Management of liquid resources 1,123
2,489 Financing
Issue of ordinary share capital 0
Repurchase of share -144
New loans 1,326
Repayment of loans -3,627 Net cash outflow from financing -2,445
Increase in cash in the year 44
Source: BT Group Annual Report 2004, http://www.btplc.com/Sharesandperformance/Howwehavedone/Financialreports/Annualreports/AnnualReports.htm
Appendix 3: Earnings per share
2000 2001 2002 2003 2004 Basic, p 27.6 -25.7 12.0 31.2 16.4 % change 160.0% -47.4% Before goodwill amortisation and exceptional items, p 29.8 17.5 6.1 14.2 16.9 % change -41.3% -65.1% 132.8% 19.0%
Source: BT Group Annual Report 2004, http://www.btplc.com/Sharesandperformance/Howwehavedone/Financialreports/Annualreports/AnnualReports.htm Appendix 4: Five year dividend history
2000 2001 2002 2003 2004 Dividend, p 19.6 7.1 2.0 6.5 8.5 % change -63.9% -71.8% 225.0% 30.8% Dividend / Earning per share before goodwill and amortisation 66% 40% 33% 46% 50%
Source: BT Group Annual Report 2004, http://www.btplc.com/Sharesandperformance/Howwehavedone/Financialreports/Annualreports/AnnualReports.htm
Bibliography and references
BT Group; Annual Report, 2004, http://www.btplc.com/Sharesandperformance/Howwehavedone/Financialreports/Annualreports/AnnualReports.htm
Financial Times; www.ft.com
