BT Group Stock (BTGOF): Maximum CapEx at Openreach

BT Group (OTCPK:BTGOF) has outperformed since our last coverage of the stock at the end of 2023. We focused entirely on the CapEx burden, which was the factor that explains BT Group’s apparent discount represented fair value. However, with the last gains a few months ago, there was a significant update, namely that CapEx peaked as costs fell to switch homes to fibre. This allows for an increase in free cash flow hopes, and more contractors available these days has allowed for lower costs per house. As before, there is still a value case for BT, but there is still a significant burden. The direction may still be positive if implementation costs continue to decline.

Latest earnings and trading update

Starting with latest full earningswe have around 11-16 million homes left in the fiber rollout. They expect to reach the target of 26 million by 2026, which is realistic given the current run rate of about 4 million homes per year, based on 1 million passed in Q4 annualized. They got another 1 million from the trading update that ended in June 2024, which means they keep that rate and are now at 15 million.

They run around 4 million homes a year now. According to our rule of thumb, it should cost around €1 billion per 1 million homes, or around £840 million. Taking the midpoints of the target, that means around GBP11 billion in outstanding CAPEX burden to bring fiber to the UK target area.

However, there may be a downside to this figure, as the company announced the CapEx peak, in part due to better launch efficiency. According to management’s disclosure, the rollout has also become around 15% more efficient per house due to the increased availability of Openreach contractors, which helps reduce costs per house. The general disinflation in terms of materials also helps.

In terms of the latest earnings performance coming from the trading update, EBITDA and revenue developments are basically flat.

Openreach, which primarily owns the long-haul wired business for BT, is doing well thanks to the launch, and the shorter-haul Ethernet infrastructure business is seeing strong growth. BT contract takeover is struggling a bit due to competitive pressures and cost of living and line losses. So the basics are not growing that well in the consumer segment. In business, there is legacy activity that is in managed decline related to phones, putting pressure on results.

Conclusion

We want to talk about evaluation. Swisscom (OTCPK:SCMWY) is a comp we like to use because they don’t have a significant CapEx burden associated with their fiber rollout. These are at 7.8x EV/EBITDA on a forward basis. BT is at 4.2x EV/EBITDA on an overall basis, but this rises to around 5.5x EV/EBITDA when we factor in the one-off CapEx burden. It’s still pretty cheap, as it was in our previous coverage.

The launch is still ongoing and the announcement of the CapEx peak has already catalysed pricing, so FCF should gradually come under pressure and thus net debt growth should slow. Net debt rose last year from £18.9bn to £19.5bn due to CapEx burden and weak FCF. Also due to higher debt costs, where in the UK rates have remained even higher for longer, this has meant a significant increase in interest expenses compared to last year by over 30%. Net debt will likely continue to rise, but at least it will be slower and the end is in sight. With the end of the roll looming and management likely knowing how bad a dividend cut would be for the stock, we think it’s quite reasonable to expect the dividend not to be cut, especially since the dividend is currently supported by FCF of run rate. Overall, BT looks a lot better than when we last covered it. We’re still not crazy about telco, though, but we do see that there could at least be enough of a value case in BT to warrant consideration by some possibly more income-oriented investors.

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