Is the BT share price the bargain of the year?
It's been a torrid two years for BT(LSE: BT.A) shareholders. Back in March 2016, the shares were changing hands for around 450p. But today, the stock can be purchased for just 227p. That's a stunning share price collapse of nearly 50%. Given that the FTSE 100 has risen around 16% in that time, that kind of performance is even more frustrating for shareholders.
Is the current share price a bargain? Is now the time to take a contrarian point of view and go against the herd? Let's examine the bull case and the bear case for the telecommunications giant.
Starting with the valuation, BT shares certainly look cheap at present. City analysts currently expect the company to generate earnings of 27.3p per share for the year ending 31 March, which at the current share price, equates to a forward-looking price-to-earnings (P/E) ratio of just 8.3. The general rule of thumb is that a P/E ratio of under 15 is considered to be cheap, so on that basis, BT shares may be a bargain right now.
Furthermore, turning to the dividend yield, BT's current yield also suggests that strong value is on offer at present. Last year, the company paid its shareholders 15.4p per share. At today's share price, that payout equates to a mighty yield of 6.8%. When you consider that the FTSE 100's average is 3%, BT shares appear to offer strong income appeal.
However, before you get excited and call your broker with an order for BT shares, there are several issues you should be aware of.
The first thing to note is the company's gigantic debt pile. At 31 December, it had net debt of £8.9bn. That's a massive amount of debt, and that adds considerable risk to the investment case. Given that debt always needs to be serviced before shareholders can receive dividends, if profits deteriorate, BT's dividend could be at risk of a cut.
If that debt pile wasn't concerning enough, on top of that, it also has an astronomical pension deficit, with some analysts suggesting the deficit could be as large as £14bn. Make no mistake, that's a serious problem that needs to be addressed. Ratings agency Moody's, which last year cut its outlook for the firm to 'negative' from 'stable' has warned that BT may need to start directing significant cash flow towards the pension deficit, sooner rather than later. Again, that could have implications for the dividend and the high current yield on the stock suggests to me that the market believes it will have to cut its dividend in order to plug the pension deficit.
Lastly, investors should be aware that BT is struggling for momentum at present. The company reported a 3% decline in both revenue and adjusted earnings per share in its latest Q3 update, and for the full year ending 31 March, City analysts expect earnings to fall around 5.5%. Over the last three months, analysts have downgraded their estimates for both earnings and dividends.
Weighing up both sides, it's hard to assess whether the shares are a bargain right now. The stock is certainly cheap, and from a long-term perspective, today's share price could offer value. However, there are definitely plenty of risks to the investment case that need to be considered.
Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.