Shares of BT Group (LSE: BT-A) fell by 18% during the first hour of trading this morning after the group issued a profit warning and warned that the cost of an Italian accounting scandal could mean a hit of 530m.
Italianscandal
In October, BT announced that an internal investigation of accounting practices in its Italian business had identified certain historical accounting errors. These were expected to result in a writedown of 145m.
BT has since commissioned an independent review of the problem by accountants KPMG. It found that the extent and complexity of inappropriate behaviour were far greater than previously identified. The total cost of this accounting scandal is now expected to be that worrying 530m.
This wont just be a historical restatement of accounts. BT expects normalised free cash flow to fall by 500m this year due to the cash costs involved in unwinding these inappropriate transactions.
Problems at home
BTs Italian problems are bad enough. But the group has also issued a full-scale profit warning this morning.
Lower levels of spending by UK public sector and international corporate customers mean that full-year adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) shouldnow be about 7.6bn, down from previous guidance of 7.9bn. Normalised free cash flow is expected to be about 2.5bn, down from 3.1bn-3.2bn previously.
BTs guidance has also been cut for 2017/18. The firm now expects revenue, adjusted EBITDA and free cash flow to remain broadly flat next year.
The only potential bright spot is that BT says dividend payments will still increase by 10% in both 2016/17 and 2017/18.
Is BT a recovery buy?
BT shares have now fallen by 36% to just 310p over the last year. The shares havent traded at this level since 2013. So is this a contrarian buying opportunity?
Im not sure. Todays news has surprised the market. Some of the groups major customers must have made quite severe cuts to spending.
However, BT has been struggling to generate sales growth for years. The groups revenue fell from 20.1bn in 2011 to 18.9bn in 2016. Although the acquisition of mobile operator EE has added about 5bn to annual sales, it doesnt seem to be contributing much organic growth.
Based on todays guidance, I estimate that BT shares are now trading on a P/E of about 11, with a prospective yield of about 4.9%.
These figures may seem cheap, but Im concerned that the pressure on BTs finances will worsen over the next year. Free cash flow is now expected to be lower than expected, but demands on the groups cash will remain high.
Todays dividend guidance suggests the group will pay out about 1.5bn to shareholders over the next year. BT also faces a triennial pension valuation in June. The groups pension deficit had ballooned to 9.5bn at the end of September 2016, so itcould face additional deficit reduction payments following this summers valuation.
Overall, I think theres a good chance that things will get worse before they improve. Earnings and dividend guidance may be cut again. I wont be buying after todays news.
Roland Head 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.