BTGOF - BT Group: Things Seem To Be Turning Around

Summary

• BT Group's 3Q23 results were promising, with strong signs of reversal trend.
• Openreach's broadband line losses have reduced to 10K, indicating that the rate at which altnets are gaining fibre customers is not as fast as expected.
• The UK government's limitations on price increases and potential pension deficit growth are potential headwinds to watch out for.

Thesis

BT Group's (BTGOF) ( BT ) results were disappointing in prior quarters, but the numbers for 3Q23 showed strong trends. There have been three changes that have given me hope for the company's future. At the outset, BT has increased prices by double digits for both retail and wholesale, bringing it in line with competitors. Second, I'd like to highlight Openreach's broadband line losses have decreased significantly, which I believe will encourage investors in BT's ability to capitalize on its fibre network. Last but not least, the long-standing fibre overbuild risk in the UK should be mitigated by the increasing operational and financial difficulties across the altnet landscape.

With fewer worries about Openreach fiber monetization and the promised reduction of Enterprise's EBITDA drag, I believe these developments will ultimately reassure investors about the Group's growth outlook. Together, they should set in motion a chain reaction in which BT consistently outperforms expectations, leading to an upward re-rating in valuation.

3Q23 results

Group revenue for BT was £5.21 billion in 3Q23, with EBITDA of £2 billion and normalized FCF of £42 million. Revenue and EBITDA from the consumer sector fell short of expectations during the quarter. Whereas, fixed broadband revenue growth slowed to 1.3% y/y as ARPU growth slowed to 2.7% y/y. This does indicate that there are more recontracts at lower-priced contracts. Openreach and Enterprise were on par with projections, while the Global Division exceeded them. Openreach broadband losses have reduced to 10K.

Openreach

Revenues from BT's Openreach division increased by 4% year over year due to rising demand for fiber and ARPU. In order to set the stage for why I think Openreach is on the upswing again, let me explain. When Openreach's broadband net adds went negative in 1Q23, I worried that it was a sign of increased network competition from altnets. When those losses increased to $90k in 2Q23, my worries only grew. However, the fact that line loss was only -10k this quarter gives me hope that the rate at which altnets are gaining fibre customers is not accelerating at an alarming rate, thus jeopardizing BT's chance to monetize its fibre network.

Enterprise

While 1Q23 results for the Enterprise segment were bad, with EBITDA falling by 25%, management was confident in a turnaround at the time. I think it's safe to say that the third quarter results have given investors (and myself) confidence that management words were right and the upswing could continue in the fourth quarter. Despite the positive 3Q23 results, I still think B2B remains an area of concern.

Potential headwinds

The UK government has informed service providers to prevent price increases in April that exceed the rate of inflation. Politicians and regulators are looking into the openness of these price hikes, and the Committee of Advertising Practice is contemplating new guidelines to prevent consumers from being misled. The telecommunications industry, however, maintains that it must generate a higher return on capital in order to adequately pass on inflation and reward shareholders. In my opinion, this is an unavoidable permanent cloud over the company's head. One way to mitigate this threat is to limit the size of one's investment exposure so that a sudden market crash won't have a major impact on the value of one's portfolio.

Upcoming tailwinds/headwinds

In my opinion, BT has two major tailwinds going into FY24: a pricing tailwind and the opportunity to increase revenue by capitalizing on its full-fibre broadband infrastructure. Additionally, BT's ability to control expenses has been bolstered by a new wage agreement. Nonetheless, there are a couple of concerns that could arise. It's important to note that higher cash taxes may lead to a decline in FY24 FCF. Second, with unquoted assets valued at £13 billion, there is a chance that the pension deficit will grow.

Conclusion

In conclusion, while BT Group's prior quarters were disappointing, the 3Q23 results showed promising trends. The company's price increases, reduced broadband line losses in Openreach, and the challenging landscape for UK altnets have given me hope for BT's future growth prospects. I would rate BT as a buy given the robust turnaround growth trend as shown in this quarter earnings.

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