After I last wrote about BT Group (LSE: BT-A) in February, I went out and bought some shares for myself.
Two months later, I'm considering whether to buy some more. As the title of this article suggests, I believe the stock could quite easily climb 50% to about 350p. Indeed, I rate the telecoms giant as one of the best buying opportunities in the FTSE 100 today. Let me explain why.
A solid foundation
Value investors tend to look at companies' past performance, rather than focusing on forecasts. There's a good reason for this -- past performance often is a useful guide to the future, as it shows us what a company is capable of.
In BT's case we can see that sales and profits have been stable in recent years, although growth has been minimal. Revenue has risen by an average of 4.4% per year since 2012, while operating profit has climbed by an average of just 1.2% per year.
When sales rise faster than profits, it normally means profit margins are falling. That's been the case here. BT's operating margin in 2017 was 12.3%, down from 14.4% in 2012 and well below the peak of 17.9% reported in 2016.
One reason for this is that BT has spent heavily on network upgrades, television rights and the £12.5bn acquisition of mobile operator EE. At the same time, the group's large market share means that growth opportunities are limited.
This might not sound like a great starting point for an investment, but I believe it could be, if the shares are cheap enough.
A cash machine
One of BT's strengths is its consistently strong cash generation. In 2016/17, the group generated normalised free cash flow of £2,782m. That's about 28p per share, which covered last year's 15.4p dividend 1.8 times.
The group's shares currently trade on around 8.5 times trailing free cash flow, which is unusually cheap. Meanwhile, last year's dividend gives the stock a trailing yield of 6.6%.
I think it's fair to say that if this level of free cash flow and dividend is sustainable, BT shares could be a great income buy at current levels.
What could go wrong?
The dividend isn't the only call on BT's free cash flow. The group also has net debt of £8.9bn and a pension deficit of £9.1bn. This has risen from £6.4bn at the end of March 2016.
In its Q3 results, BT said that it is "considering a number of funding options to address the deficit". Apparently these may include giving the pension scheme a claim over certain BT assets, rather than just additional cash payments.
My price target is 350p
Getting the pension deficit under control and reversing the group's declining margins are two of the challenges facing the new chairman, City veteran Jan du Plessis.
But with a forecast P/E of 8.5, I believe a lot of bad news is already priced into the stock. If Mr du Plessis can maintain the dividend and deliver a convincing growth plan, I think a P/E of 12 might be reasonable.
Based on profit forecasts for 2018/19, a P/E of 12.4 would lift the shares by 50% to 350p. I don't expect this to happen overnight, but I do think it's realistic. I rate BT as a strong value buy.
Roland Head owns shares of BT Group. 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.