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Morningstar | BT Reported Improved Fiscal 3Q Results but Offset by Higher Pension Deficit; Shares Undervalued

BT reported fiscal third-quarter revenue and EBITDA that was a bit better than our expectations, but the pension deficit widened by GBP 500 million, offsetting this improvement. Thus, we expect to maintain our GBX 360 per local share fair value estimate and narrow moat rating. We believe the shares are significantly undervalued. No financials were provided beyond EBITDA.

The firm reported revenue fell 1% year over year during the quarter versus our full-year projection of a 1.9% decline. The consumer division, which accounts for over 40% of revenue, increased 4%. However, it continues to be the only segment generating revenue growth. It benefited from a price increase in September 2018. Management announced it would not increase prices again in 2019 but would raise prices in line with the CPI beginning in 2020. No price increase in 2019 could bring its revenue growth rate down slightly in fiscal 2020, but we expect it will remain positive due to broadband subscriber growth.

While other divisions continue to generate lower revenue year over year, there are segments in global services, enterprise--which now incorporates the old business and wholesale divisions--and Openreach that have produced higher revenue in the past two quarters than in the first quarter. While there is some seasonality, we think the improvement goes beyond that and reflects improvement in the business. We think Openreach can grow its revenue next year and the other divisions’ revenue declines will lessen, allowing the company to generate some total revenue growth.

While revenue declined at the global services division, cost-cutting was sufficient to increase its EBITDA. This allowed the firm to generate an EBITDA margin of 31.4% in the quarter, in line with our full-year projection. However, with the first and second quarters generating higher EBITDA margins than the third quarter, and the fourth quarter historically having the highest margin of all, BT should beat our full-year estimate.

BT began to ramp up its fibre-to-the-premises, or FTTP, buildout in the quarter passing an additional 211,000 premises. This is a 31% increase in the number of premises passed. We expect the buildout to ramp even faster next year, which should help generate revenue growth at Openreach.