Two things investors should know about BT before buying for the 5.3% dividend

BT pension deficit dividend cut

Over the last 18 months, BT Group (LON:BT.A) (BT.A.L) shares have fallen from around 500p to under 300p, a decline of over 40%. With the telecommunications giant paying out 15.4p in dividends for FY2017, the share price fall has pushed BT’s dividend yield up to a huge 5.3% right now.

While that yield no doubt sounds attractive in the current low interest rate environment, if you’re thinking about purchasing BT shares for the dividend, there’s a few things you should know before you buy.

Dividend growth to slow

BT has grown its dividend significantly over the last five years, lifting the payout from 8.3p per share to 15.4p per share, a compound annual growth rate (CAGR) of over 13%. That’s an impressive rate of growth. However, going forward, investors should not expect the same level of growth in the medium term.

BT announced a profit warning back in late January, informing investors that due to an investigation into improper accounting practices in its Italian business, a writedown of £350m would be required. The company also advised that the outlook for UK public sector and international corporate markets had deteriorated and that earnings would be lower than previously advised. The consequence of all this is that dividend growth in the next few years is set to be lower than in recent years. In May, BT stated that while its dividend policy remains ‘progressive’, dividend growth for 2017/2018 will be “lower than the 10% previously anticipated.

So what level of dividend growth can we expect from here? As present, City analysts currently forecast dividend growth of 4.3% and 5.0% for the next two years.

High debt levels & a gigantic pension deficit

Dividend investors should also be cautious of BT’s high debt levels and the pension deficit currently sitting on the balance sheet.

As a dividend investor, in my view the less debt a company has the better. That’s because high levels of leverage can make a company more vulnerable if profitability slows down. A company’s debt payments will always have priority over dividends to shareholders, meaning that if profitability was to suffer, the dividend payout could be at risk.

With total long term debt of around £10bn on the balance sheet, BT’s debt levels are clearly high. Indeed, ratings agency Moody’s changed its outlook on BT from ‘stable’ to ‘negative’ in January this year on concerns that lower profits would make the company’s debt pile more difficult to service.

Another concern is BT’s underfunded pension scheme, which according to analysts at MSCI, is the second worst funded pension scheme in the world, at around £9bn.

Significant pension liabilities are another issue to watch out for as a dividend investor, as the company will often need to direct funds towards the pension to reduce the size of the liability. Naturally, this means less funds for dividend payments.

So while BT’s dividend yield of 5.3% looks attractive, the investment case from a dividend investing perspective is certainly not risk free.

Disclosure: Edward Sheldon, CFA has no position in BT. 

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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