BT Group (LSE: BT-A) and Royal Mail (LSE: RMG) are two of the UK’s oldest companies, with a combined 676 years of business between them.
Both are seriously out of favours as their managements grapple with the challenges of modernisation and changing demands.
The BT share price has fallen by 55% over the last five years. The Royal Mail share price is down by 44% over the same period.
Clearly there are problems. But these remain large, profitable businesses. At the time of writing, BT boasts a yield of 8.8%, while Royal Mail offers 7.7%.
I’ve been tempted by both stocks, but I’ve only bought shares in one of them. In this article I’ll reveal which stock I’ve bought and why I chose it.
What’s gone wrong?
I think it’s worth taking a brief look at the problems being faced by each company. Both face very similar issues, in my view.
Both are capital-intensive businesses which must invest heavily in equipment and staff to deliver.
That wasn’t a problem when service requirements were unchanged. But they now face strong demand for costly newer services (parcels and high-speed broadband) and falling demand for cheaper traditional services (letters and voice calling).
To meet this demand, both firms need to invest in new equipment and make changes to their workforces. Funding this investment and gaining support from staff won’t be easy.
Are more dividend cuts likely?
Royal Mail boss Rico Back has already cut the group’s dividend. Starting from the current year, the full-year payout will be cut from 25p to 15p. Extra payments will be made if surplus cash is available. I wouldn’t expect anything for the next year or two.
BT hasn’t cut its payout yet, but chairman Jan du Plessis opened the door to the idea at the firm’s AGM earlier this year. According to the FT, Mr du Plessis told investors that “a year or two in the future” the firm might cut the dividend to provide additional funds for its fibre broadband rollout.
City analysts are forecasting a 12% cut to the payout in 2020/21. Based on estimated costs for the fibre rollout, I think a bigger cut is likely. However, even if the current 15p payout was cut by a third to 10p per share, the stock would still yield almost 6%. I’d be happy with that.
I’ve bought BT shares for my income portfolio. There are two reasons why I’ve chosen telecoms over postal services.
The first is that my instinct suggests the long-term growth story for data and networking services is stronger than for parcels and letters.
The second reason is the human story. I have a positive impression of BT chairman Jan du Plessis from his previous leadership roles at miner Rio Tinto and British American Tobacco. I don’t think he’d have taken this job without being confident he could deliver.
I also think that it’s likely to be easier for BT to make the necessary changes to its workforce than it will be for Royal Mail. The postal service is again facing the threat of strike action and has large competitors with much lower cost structures.
Although I expect a BT dividend cut at some point, I’m fairly confident the current share price represents a good long-term buying opportunity.
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Roland Head owns shares of BT GROUP PLC ORD 5P. 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.
Motley Fool UK 2019