Berenberg drops BT to 'hold' on dividend concerns

Analysts at Berenberg downgraded UK telecoms giant BT to 'hold' on Tuesday as it questioned whether the group's normalised free cash flow would be enough for it to meet its strategic targets while maintaining its dividend payout.

Berenberg said BT's normalised free cash flow of almost £2.5bn was roughly £1bn higher than its dividend cost of £1.5bn.

However, the German bank noted that from this £1bn, BT has to support its pension deficit, buy spectrum, buy back employee share options to prevent dilution and fund restructuring.

"If new CEO Philip Jansen wants to increase investment to drive a return to growth, this would shrink the £1bn of headroom for such costs, putting the dividend under pressure," said Berenberg.

Carl Murdock-Smith and his team of analysts also highlighted concerns surrounding the group's rising debt.

Berenberg pointed out that net debt was principally increasing due to BT's pension deficit payments, spectrum, restructuring and one-off tax phasing but it noted that even once these mostly normalise by 2020/21, consensus estimates still had net debt rising.

IFRS 16 may also add £4bn-5bn to reported net debt as the firm's 2001 sale and leaseback of its exchanges moves on to its balance sheet, he added.

"Along with the pension deficit, this reminds us that BT's balance sheet is not as strong as it appears at first glance," said Berenberg.

The broker did concede that prioritising investment over dividend may be right for the long term but investors "will not like it".

Looking forward, Berenberg said financial trends would "remain challenging" in the first half of the trading year, meaning there was little coming from BT to "excite" in the next six to nine months.

"Beyond this, we are constructive on: 1) cost transformation; 2) cash flow upgrades from a possible retrenchment of BT Sport; 3) increased collaboration with Deutsche Telekom; and 4) pension deficit inputs to be proven too conservative in the long term," concluded BT, which also cut its target price on BT from £2.75 per share to £2.60.