Can BT Outperform KCom?

LONDON -- If you're interested in building a profitable, diversified portfolio, then you will often need to compare similar companies when choosing which share to buy next. These comparisons aren't always as easy as they sound, so in this series, I'm going to compare some of the best-known names from the FTSE 100 (UKX), FTSE 250 and the U.S. stock market.

I'm going to use three key criteria -- value, income, and growth -- to compare companies to their sector peers. I've included some U.S. shares, as these provide U.K. investors with access to some of the world's largest and most successful companies. Although there are some tax implications to holding U.S. shares in a U.K. dealing account, they are pretty straightforward and I feel are outweighed by the investing potential of the American market.

Today, I'm going to take a look at FTSE 100 stalwart BT Group (BT.A -0.30%) (BT) and its smaller FTSE 250 peer KCom Group (KCOM). All data is sourced from Morningstar, Reuters, and company reports and uses the most recent reported information.

1. Value
The easiest way to lose money on shares is to pay too much for them -- so which share looks better value, BT, or KCom?

BT and KCom are remarkably closely matched here, with only BT's unappealing P/B ratio dividing the two companies. The problem is that BT has 12 billion pounds of short- and long-term debt, plus a 3.1 billion-pound pension deficit. Once the value of these has been subtracted from BT's assets, the firm's net asset value per share is extremely low, which gives rise to its very high P/B ratio.

Neither share is a value play at current valuations, and it's worth nothing that BT's low P/E ratio is quite flattering -- if enterprise value (market capitalization + net debt) was used instead of price (market cap), then BT would look more expensive than KCom due to its greater debt burden. Enterprise value is often considered to be the true cost of buying a company, as any buyer needs to purchase all of a company's shares and assume responsibility for all of its debt.

2. Income
With low interest rates set to continue for the foreseeable future, dividends have become one of the most popular ways of generating an investment income. How do BT and KCom compare in terms of income?

KCom wins the income contest hands down. Not only are KCom's current and forecast yields far higher than those of BT, but its recent dividend growth history is healthier, too. Although both BT and KCom were forced to cut their dividends in 2009, KCom has recovered much faster, and its forecast dividend for the 2012/13 financial years is 193% higher than its 2009 dividend. BT's forecast dividend, on the other hand, is only 45% higher than it was in 2009.

Although 45% is not a bad income increase over five years, 193% is a lot better -- especially as dividend cover remains a fairly prudent 1.9 times. KCom's dividend yield has been helped by the 15% slump in its share price since October, when it issued a cautious trading statement and reported a rise in net debt. However, assuming the company manages to stay on top of its debt and protect its margins, I think that this will prove to be a good opportunity to lock in an excellent yield.

3. Growth
Even if your main interest is value or income investing, you do need to consider growth. At the very least, a company needs to deliver growth in line with inflation -- and realistically, most successful companies need to grow ahead of inflation if they are to protect their market share and profit margins.

How do BT and KCom shape up in terms of growth?

Both KCom and BT have reported declining revenues over the past five years, but the big difference is that KCom has substantially improved its profitability, increasing its operating margin from 4.6% in 2008 to 15.2% in 2012. BT's operating margins have been far less reliable, although 2012 did see a recovery to 14.2% -- almost the same level as 2008. KCom's rising margins have fuelled healthy growth in its earnings per share, while BT's EPS have fallen by an average of 4.5% per year. The companies' share prices tell the story -- while BT's share price has performed poorly since 2008, KCom has delivered a healthy return of 29%, which when added to its attractive dividend payments, equates to a pretty decent total return for long-term investors.

Looking forward, I would bet on seeing KCom continue to outperform BT in the growth stakes -- it's smaller, nimbler, and more focused.

Should you buy BT or KCom?
KCom is a slightly quirky business that has been developed from the local telecom business that serves the area around Hull, which has never been part of the BT network. Today, it offers class-leading broadband services to customers on its network and is working hard to develop its enterprise services for business customers.

Although BT's share price has recovered somewhat this year -- mostly because the company promised to step up its dividend payments and put 2 billion pounds into its pension -- I don't think that its underlying problems have been solved. BT's debt and pension deficits remain, and it is now investing heavily in its new subscription television service, BT Vision, which aims to compete with Sky's Premiership football channels -- but has yet to acquire the audiences needed to justify the 890 million pounds it has spent so far this year on sports broadcasting rights.

There's only one of these shares I might consider buying at the moment, and it's KCom. Despite this firm's modest 367 million-pound market capitalization, I think it is a far more attractive income and growth investment than BT, which is burdened by the legacy of past mistakes that I believe will continue to impact the firm for some years to come.

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