Who's just upgraded BT to 'buy'?

BT's problems have been widely discussed, and there's good reason why its once mighty share price halved from a fiver at the beginning of 2016, to under 250p less than a month ago.

But this pounding has attracted bargain hunters, and there are some who now believe that the blood-letting is over. A forward price/earnings (PE) ratio of less than 10 and forward dividend yield of 5.8% is certainly worth investigating.

UBS has run the numbers and thinks BT shares are undervalued. It's just upgraded its rating on the shares from 'neutral' to 'buy' and lifted its price target by 20p to 330p, largely driven by a lower pension deficit - £6.5 billion gross versus consensus of £11-£12 billion.

"We remain cautious on the fundamentals for BT but, at current levels, we think the downside from overhangs weighing on the share price (FTTH [ultrafast broadband] capex/pensions/ Premier League) is priced in and that newsflow over the coming quarters could turn more positive.

"Our estimates are little changed, and we expect stable EBITDA and normalised EFCF [Equity Free Cash Flow] over the coming years – in line with consensus."

The first of what could be a series of potentially positive catalysts arrives in the coming weeks when Openreach gives an update on FTTH economics. In February, there's also the chance that government support could reduce or reverse regulatory cuts on wholesale fibre (WLA) pricing, which the broker believes could mark the start of "an inflection in earnings momentum".

We'll get news on pension deficit payments in January, outlining changes in indexation of benefits for certain scheme members, plus a possible end of the defined benefit scheme for existing employees. An agreement with the pension trustees on the deficit looks could also come sooner than May.

Then there's the Premier League rights auction, likely in February. UBS believes the cost of rights to be flat in the coming cycle at around £320 million to BT. Others pencil in a 40% increase for both Sky and BT, which reflects more games and possible competition from Amazon and Facebook.

But what do these three specific factors mean for the dividend?

"[This] could theoretically put significant pressure on the EFCF of the company and lead to a cut in the dividend," warns the broker.

However, both BAE Systems and Tesco surprised positively in their recent triennial reviews, and UBS thinks BT could, too. "While we see specific one-off issues in FY-18 and FY-20 that will depress EFCF, we think the dividend can be maintained."

"The EFCF yield is 10.6% for 2018e before pension costs, and investors could switch to this metric if there is confidence that the pension deficit will narrow materially over time, or if there is improving earnings momentum."

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.