Shareholders of Vodafone(LSE: VOD) and BT(LSE: BT.A) have every right to be upset with their companies' performance this year. As the FTSE 100 has rallied, shares in Vodafone and BT have languished. Year-to-date shares in Vodafone have underperformed the UK's leading index by around 10% and shares in BT have underperformed by almost 30% excluding dividends.
Here at the Motley Fool, we encourage long-term investing and usually, a one-year blip wouldn't be a reason to sell. However, the underperformance of these two telecoms giants may reflect deeper issues investors have with the companies, and these underlying structural problems may be reason enough to sell.
Shares in Vodafone have been struggling for a few years. The company has been investing heavily in its network infrastructure and these investments have dented profitability. What's more, the group is suffering from changing consumer habits as customers move away from highly profitable voice and text packages towards data packages, which are less lucrative and require more investment on the company's part in the long-term.
Still, after several years of heavy spending to get the company's network infrastructure up to scratch, City analysts expect Vodafone to return to growth this year. Earnings per share growth of 35% is pencilled-in for the year ending 31 March 2017. Vodafone is expected to earn 6.8p per share for this period, which means the shares are trading at a forward P/E of 35.2.
This may look like a premium valuation at first glance but the company's shares support a dividend yield of 5.5% and it would appear that the market is valuing the shares based on this yield alone.
Vodafone operates in a highly defensive industry, and the shares have bond-like qualities, so it seems the market is treating the shares like a bond. If this is the case, it's clear why shares in Vodafone have underperformed this year. The market is quite happy with the company's slow and steady performance and as an income investment, Vodafone remains attractive.
All in all, it doesn't make sense to sell Vodafone just yet.
BT has arguably more problems stalking the company than Vodafone. For example, this year the company has been investigated by Ofcom regarding its dominance of UK telecommunications infrastructure and there are worries about the company's ballooning pension deficit. Further, some City analysts have begun to voice concerns about the high price BT is paying for content to compete with peers like Sky in the highly competitive pay-TV market.
It's BT's pension deficit that is arguably causing the most concern among investors.
At the end of May was estimated BT's pension deficit had hit £10bn and as interest rates have plunged over the past few months it's likely this deficit has only widened further. According to analysts at Australian bank Macquarie, to be able to fill this shortfall BT will have to increase its pension payments by £1bn a year until 2030. The additional deficit funding requirements could put pressure on both BT's dividend and investment plans.
Investors look to BT as a defensive dividend stalwart but the risk to the company's dividend, in this case, is too great. With a yield of only 3.6% at time of writing, there are better income opportunities out there -- without the enormous pension overhang -- for BT's investors.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.