BT’s shares buzzing but JP Morgan thinks they can go higher

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BT Group PLC (LON:BT.A) shares have risen on the back of a surprise result from the UK mobile spectrum auction and the conclusion of a regulatory review of the broadband market yesterday, but JP Morgan and Berenberg analysts expect them to climb further.

Ofcom’s wholesale fixed telecoms market review concluded by giving BT’s ‘arms length’ infrastructure subsidiary Openreach more clarity, which the FTSE 100 company followed by committing to investing £12bn in expanding superfast broadband connections around the country.

READ: BT Group welcomes fibre-to-the-premises ‘green light’ to ‘build like fury’

JP Morgan, after tuning in to an Ofcom conference call, said BT has “greater clarity and a much more constructive tone” from the regulator.

The investment bank reiterated its ‘overweight’ rating on Friday and kept its 175p share price target, versus the 151.3p closing price.

The Ofcom review gave Openreach “the most regulatory visibility that it has ever had”, said Berenberg in its own note on Friday.

These were two of the four positive catalysts that the Berenberg analysts view as “key to investor sentiment improving towards BT”.

READ: Ofcom to hold off from insisting on cost-based prices for fibre services for at least 10 years

They expect the investment case to look “considerably cleaner by the summer”, with BT’s triennial pension review to conclude in the coming months, “with deficit contributions lower than consensus expects”, and then a Premier League broadcast rights auction also in coming months, where Berenberg expects BT will pay 10% less in the than the £325mln per year it does currently.

On the company’s financial performance, underlying profits (EBITDA) are forecast by Berenberg to turn to growth from the first quarter of the 2021/22 financial year as COVID-19 headwinds start to annualise, according to the bank’s above-consensus estimates.

The UK spectrum auction that concluded on Wednesday, with total bidding of £1.4bn and BT’s payment of £452m being considerably below expectations of £2.5bn and £700mln, the German bank said, with competitive tension seem to have been eased by Vodafone and Three being comfortable with their already strong holdings in other sections of the spectrum.

On the Ofcom decision, “as with any regulatory announcement,” JP Morgan said, “the key challenge is that of having to navigate through an extremely lengthy publication (in this case 1600 pages!)”.

While attention has focused on the headline that Ofcom is unwilling to “predetermine” a particular premium that BT can earn on its fibre, leaving investors unclear on what this ultimately meant for BT, Ofcom’s analyst call “offered reassures that increase confidence that BT will be able to earn the 10-12% return it is targeting”.

Furthermore, while Ofcom did not specify the weighted average cost of capital (WACC) it will use for BT’s fibre build, on the call management clarified this would be “north of that calculated for the rest of the UK telco industry”, which is currently 7.8% versus BT’s last reported 9.3%.

Ofcom may have stopped short of articulating the “premium” to WACC Openreach will be allowed to earn, but it acknowledged a historic investment premium of 3-4% and noted its desire to be both consistent and promote investments.

Ofcom re-iterated that 2031 was the earliest date at which they would move to cost based regulation but Ofcom said if retail price points across “competitive” and “noncompetitive” fibre regions prove to be similar then it is unlikely to adopt cost base regulation.

However, if it is introduced, then JPM noted that Ofcom’s new policy of using “economic depreciation” rather than “accounting depreciation” will mean the bulk of £12bn fibre spent will remain on the Openreach balance sheet, “leaving a larger ‘residual’ asset base against which it can continue earning cost of capital (whilst retaining the premium returns already achieved)”.

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