Declines at BT(LSE: BT.A) over the past year have sent the stock down to levels not seen since 2013 and the company's dividend yield has spiked to 5%, attracting the interest of income investors.
However, while BT's dividend yield now looks attractive compared to the wider market, I do not believe the payout is sustainable at its current level. Three major headwinds are buffeting BT's business and it does not look as if these pressures will dissipate anytime soon.
Three key issues
The issues facing BT can be boiled down to the three Cs: competition, costs and creditors.
First off, BT's revenues are coming under increasing pressure from both established and new players to the telecoms industry. Advances in technology mean that consumers no longer have to rely on BT's old-fashioned network infrastructure to make telephone calls or use the internet. Several internet service providers now offer packages that make use of mobile networks to deliver the web into people's homes.
Fixed line demand is also dying out as most consumers now own mobile phones. So far, BT has been able to improve profitability despite these issues by investing in higher margin services such as pay-TV. But even this market is now coming under attack and the company is having to pay more to gain control of lucrative sports broadcast rights.
This brings me onto my second point, costs. Together, BT and Sky have spent over £5bn on rights to Premier League matches in an attempt to attract customers. To pay for this spending, both companies are planning to hike prices charged to customers this year.
BT is planning to charge £3.50 a month from August for its sports channel, previously free to broadband users. While increasing the price of basic broadband by £2 a month and high-speed broadband by £2.50 a month from April. Sky is raising standard line rental £1.49 for all but landline-only customers. This latest round of cost hikes raises the question of how much more consumers can take. The wholesale cost of leasing phone lines has fallen 25% over the past five years but phone bills have increased 28%, and broadband bills have increased 41% over this period.
Lastly, BT needs to keep its creditors happy. The company has business debt of £9.6bn and a pension deficit of £11.5bn. If creditors demand more from the company, BT could find itself in a sticky situation.
A better opportunity
Combined, all of these factors lead me to believe that BT's dividend isn't sustainable at current levels. If competition and costs really start to bite, BT will have to slash the payout to meet interest costs and pension obligations.
BT's peer, Vodafone(LSE: VOD) looks to be in a much better position. Shares in Vodafone currently support a yield of 6.3% and the company is one of the disruptors making life hard for BT. The company has one of the world's largest mobile networks and recently entered the UK broadband market.
Not only is Vodafone a BT disruptor but it's also active in faster-growing markets such as India and South Africa giving investors a degree of global diversification. Put simply, if you're looking for a high yielding telecom share, Vodafone could be a better buy than BT.
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Rupert Hargreaves owns shares of Sky. 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.