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Fitch Affirms BT Group plc at 'BBB+'; Outlook Stable
September 25, 2017 / 5:33 PM / 22 days ago

Fitch Affirms BT Group plc at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, September 25 (Fitch) Fitch Ratings has affirmed BT Group plc's (BT) Long-Term Issuer Default Rating (IDR) at 'BBB+'. The Outlook is Stable. A full list of rating actions is below. BT's ratings take into account its broad scale, business diversification and established market positions across a competitive UK communications market. A series of problems including cash-flow restatements following the discovery of unauthorised accounting practises in BT Italia, headwinds in Global Services and the company's public-sector operations have led to a materially rebased level of normalised free cash flow. Despite these pressures Fitch considers underlying cash flow to be consistent with its 'BBB+' peer group and leverage headroom good. Investor confidence has been impacted given what had been viewed as a strong management track record. Fitch considers the underlying strengths of management strategy remain in place, evident in the stable to growing revenue trends in most of the business, a well-executed consumer broadband and content strategy, the EE acquisition and effective management of regulatory risk. KEY RATING DRIVERS Rebased Cash Flow, Ratings Headroom: The past year has been a difficult one, with the group subject to a series of high-profile and sizeable cash-flow impacts, the like of which would previously have been regarded as inconsistent with management's record. Problems in BT Italia, and headwinds in Global Services and its public-sector operations have effectively rebased normalised free cash flow by around GBP0.6 billion - GBP0.7 billion pa. However, the majority of the business continues to perform well and overall cash-flow strength supports its ratings. Forecast March 2018 FFO net leverage of 2.3x, although weakened, shows headroom versus a downgrade threshold of 2.5x. Diversified Service Platform: BT lacks the geographic breadth of some of its large incumbent peers. A GBP24 billion revenue, GBP7.6 billion EBITDA business is nonetheless sizeable, and underlying cash flow consistent with its peer group. One-off items in the financial year to March 2018 (FY18), regulatory settlements, EE integration, restructuring and a DT/Orange warranty payment will all pressure free cash flow, which is nonetheless expected to recover quickly. The breadth of operations was strengthened by EE acquired in 2016, and the group is positioned strongly in consumer, mobile, corporate and wholesale markets. Network access division, Openreach (34% of FY17 EBITDA) is a high-margin (52% FY17 EBITDA margin) and visible business. Regulatory Overhang Addressed: BT has faced persistent regulatory questions over its ownership of Openreach and whether it might be forced to separate the network access business. Final conclusions of Ofcom's digital communications review have settled on legal separation with Openreach subject to a high level of reporting transparency and independence, but remaining part of the BT group. Ofcom's conclusions nonetheless provide important regulatory clarity. Consultations with communications-provider customers over desired levels of investment may lead to heightened capex driven by the infrastructure division. Prudent Financial Policy: Notwithstanding the reputational impact of recent events, Fitch considers BT's approach to capital allocation, financial policy and regard for constituent stakeholders to be measured and balanced. Dividend policy has been tempered in light of near term cash-flow pressures, and share buybacks contained to those needed to eliminate the dilutive effects of share-based compensation. Management is committed to reducing net debt and to its current rating levels. The way management has responded to events continues to support our view of a prudent financial management; one with due regard to ratings and fixed-income investors. Conservative Ratings Threshold: BT's main ratings downgrade threshold of FFO net leverage consistently above 2.5x is set conservatively relative to its peers - the large incumbent-like 'BBB+' operators subject to a downgrade threshold of 3.5x, and lower-rated operators such as KPN (BBB/Stable) or TDC (BBB-/Stable) implicitly enjoying 0.5x of incremental ratings headroom in their downgrade guidelines. UK market competition in both fixed and mobile is high, convergence and content viewed as important and regulatory pressures more apparent. The scale of BT's pension recovery plan payments could impact FFO. All these factors demand a more cautious threshold. DERIVATION SUMMARY BT's ratings sit comfortably among its 'BBB+' rated telecoms peer group. While the company lacks the scale and geographic diversification of Deutsche Telekom, Orange and Vodafone (all BBB+/Stable), BT nonetheless enjoys strong market positions across all market segments of its domestic market, has delivered strong operating efficiencies and despite recent difficulties exhibits revenue and cash-flow visibility consistent with the peer group. A competitive UK market environment, regulatory pressures and pressure exerted by high pension plan recovery payments mean that downgrade thresholds are set more stringently than its peer group. Its larger 'BBB+' peers enjoy exposure to a number of markets, providing mitigation to potential weakness or a downturn in domestic performance. This diversification also offers levers to defend financial metrics in the event of leverage pressure ie. through asset sales or minority listings; levers that are more limited at BT. No country-ceiling, parent/subsidiary or operating environment aspects impact the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - flat FY18 revenue growth followed by low single-digit growth driven by continuing strength in the consumer operations and a stronger competitive position in enterprise following the EE acquisition; - EBITDA margin to remain in the low thirties with rising incremental content costs being offset by stable and improving retail revenues, ongoing cost efficiencies and the realisation of targeted EE integration synergies over a five-year horizon; - FY18 specific items cash-flow impact including GBP300 million two year business transformation costs (the majority taken in 2018), GBP225 million warranty settlement and GBP342 million deemed consent payments; - dividend payments in the region of GBP1.6 billion per annum and share buybacks of GBP200 million pa. in the current year. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Fitch considers BT's mainly domestic focus, and it competitive and regulatory environment are likely to limit further ratings upside. A tangibly reduced leverage profile coupled with a significant easing in the competitive and regulatory environment would be necessary before an upgrade was considered. In times of financial stress larger more diversified operators tend to have levers such as asset sales or minority listings available to them - levers that are less available to BT. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - A downgrade to 'BBB' would be likely if FFO net adjusted leverage was expected to remain consistently above 2.5x. - Deterioration in the key operating and financial metrics at BT's main operating subsidiaries, or significant risk-taking in relation to the development of BT Consumer's pay-TV offering would also be negative. LIQUIDITY Liquidity Remains Strong: BT continues to be a cash-generative company. As of 1Q18, the company reported unrestricted cash of GBP3.7 billion and access to an undrawn RCF of GBP2.1 billion. Not only does this sufficiently cover short-term debt, it also covers debt payments due in FY19 and FY20. FULL LIST OF RATING ACTIONS BT Group plc Long-Term IDR: affirmed at 'BBB+'; Outlook Stable Short-Term IDR: affirmed at 'F2' British Telecommunications plc Long-Term IDR: affirmed at 'BBB+'; Outlook Stable Short-Term IDR: affirmed at 'F2' Senior unsecured rating: affirmed at 'BBB+' Commercial paper programme: affirmed at 'F2 Contact: Principal Analyst Joe Howes Analyst +44 20 3530 1382 Supervisory Analyst Stuart Reid Senior Director +44 20 3530 1085 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Damien Chew, CFA Senior Director +44 20 3530 1424 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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