Stockwatch: End of the line for this blue chip?

Are the best days for capital growth now over? BT's chart since 2011 is one of the strongest in the FTSE 100 index, rising from 160p to 500p by late last year. This reflects a circa 30% market share in fixed-line services, largely due to an historic state monopoly where BT Openreach still owns/manages the network, although it only has 1% or so of the mobile market.

BT has benefited from customers upgrading as technology advances, and from the "bundled" approach where broadband service demands line rental also, and telephony usually follows.

BT's £12.5 billion acquisition of EE, relative to a current market cap of £46 billion, extends capability in mobile and convergence of various services including TV. As a corporate development story BT has been a good one; but what of its overall risk/reward profile?

Shareholder returns less appealing

At 470p, the stock is down with the market this year, but the table shows more fundamental issues. Earnings growth is seen moderating from generally double-digit rates into single figures with a price/earnings (PE) multiple in the mid-teens.

Moderating earnings growth is partly due to last year's £1 billion equity placing, but the fact remains, the PE-to-growth (PEG) ratio now stands at 2.1 to 1.7 where ideally you are looking for less than 1.0. Back in 2011 it was as 0.4. Obviously this relates to forecasts, so if BT can regain momentum to work through the equity dilution over time, then a currently unattractive PEG may improve.

If the market becomes minded to such risks it could de-rate BT over time to exact a better yield than 3%

Mind how the business is operationally riskier, though, as telecoms become more competitive, hence less freedom to price. Also, BT Openreach is now a target for claims it should be divested (or at least enjoy less margin) and questions whether broadband service is satisfactory.

If the market becomes minded to such risks it could de-rate BT over time to exact a better yield than 3% or so currently. That's not enough to attract income investors versus plenty of other higher yields currently. If capital growth investors decide to move on, then the point where buyers and sellers meet could be significantly lower: e.g. since Vodafone went ex-growth its stock has trended broadly sideways on a 5.5% yield.

Much also depends on the resilience of British consumers and firms in a wider economic context. If there is a slowdown then BT would be susceptible to competition, its services being relatively expensive even on a packaged basis. That's fair enough if the service is worth paying for, otherwise customers may only be retained by the threat of financial penalties for leaving a contract early – which competition regulators may eventually tackle anyway.

Service quality problem

BT's latest update cites the third quarter to 31 December with revenue up 4.7%. "Our best result for more than seven years," crowed chief executive Gavin Patterson. We are making good progress towards our goal of sustainable profitable revenue growth BT Consumer has a standout quarter...capturing 71% of new broadband customers... who like what we're offering, whether that's superfast broadband, Champions League football or mobile data. Global also did well with good revenue growth in continental Europe and Asia."

Investors must hope the chief's tone reflects a majority experience that can overcome setbacks. Criticism remains of generally poor internet connectivity and speeds while 121 cross-party MP's argue that Openreach should be forcibly divested.

121 cross-party MP's argue that Openreach should be forcibly divested

Despite receiving £1.7 billion of taxpayers' money, they say the "natural monopoly" of BT and Openreach is holding the economy back. The Centre for Policy Studies has weighed in also, and Ofcom is due to report later this month.

I am actually one of those customers, BT's chief executive crows about. But it's been a disastrous change of ISP after nearly 20 years of solid service. BT's sales team implored, fibre broadband would ensure "a stronger more reliable connection" but it can drop repeatedly early-mornings, during evenings and at weekends.

Near neighbours who contracted the faster BT Infinity 2 to watch films, are similarly frustrated. After nearly five months the matter is still not resolved. Recently the "Level 2, escalated complaints department" was too busy to call me when booked, calling instead four days later. Quite simply it would appear BT has over-promised on the capability for fibre broadband over copper lines.

A crisis of confidence?

Part of the problem getting faults resolved appears to be the culture within Openreach itself: e.g. when an engineer does arrive they have no context of what has happened previously. Each engineer has a daily number of tasks to resolve, hence the trickier jobs end up delayed: a phone-line fault on the road where I live took six weeks to resolve last summer. Among a string of engineers visiting, at least two expressed the same frustration with Openreach management: "The left hand doesn't know what the right is doing in this organisation".

BT has enjoyed a good run in recent years, but price/value and the underlying context are getting trickier

So frustration appears to be simmering both at ground level and among policy-makers, and while controversy over Openreach should not be blown out of proportion it is nuisance grit in BT's growth story.

TalkTalk Telecom had a separate issue by way of a customer accounts hacking scandal, yet is comparable in the sense of showing how a well-rated telecoms stock can lose its halo. Over the last nine months, TalkTalk has halved, albeit from a daft PE anyway: 40, down to about 20 times forward earnings. Effectively, the scandal helped prick an over-inflated stock, where the market now exacts a 5.6% prospective yield, albeit uncovered by earnings. TalkTalk's commercial appeal has mainly been price, although many customers have been frustrated over service.

All this begs questions whether the Conservatives' 1984 privatisation of a state monopoly was appropriate. Achieving high-quality nationwide broadband certainly doesn't square with privateers exploiting the best areas, while Openreach also has to support those less populated. A competitive culture within Openreach doesn't appear able to meet the task either.

Consider locking in gains

BT has enjoyed a good run in recent years, but price/value and the underlying context are getting trickier. On a risk basis it looks wise to consider locking in at least some gains, lest the stock changes status towards a yield play as Vodafone has done. In that case, BT's board must either increase the payout or the price will trend lower.

For more information see the company's website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.