How BT Group Will Deliver Its Dividend

LONDON -- I'm looking at some of your favorite FTSE 100 companies and examining how each will deliver their dividends.

Today, I'm putting telecommunications giant BT Group (BT.A 0.29%) (BT) under the microscope.

Dividend past
I'm not going to dwell too long on BT's woes in the immediate aftermath of the dot-com crash. Debt-laden BT passed a couple of dividends amid a major boardroom restructuring, a rights issue that raised almost 6 billion pounds, and asset sales, including Yell for over 2 billion pounds. (The sale of Yell doesn't look bad business today, because the directories group, now known as Hibu, is valued at just 8 million pounds!)

Moving on to the next major stock market meltdown, BT was caught out again and slashed its 2008/9 dividend by almost 60%, from 15.8 pence to 6.5 pence. The board said the move would: "Allow the dividend to grow at the same time as investing in the business, reducing debt and supporting the pension scheme."

By the following year, the board was sufficiently confident it had got the balance right between dividends and its other priorities that it "committed to paying progressive dividends over the next three years to 2012/13."

Current state of play
Before the three years were up BT management's confidence had grown still further. The board said, when announcing the 2011/12 results: "As a result of our confidence in our ability to grow free cash flow, we intend to increase the dividend per share by 10%-15% per year for the next three years."

BT delivered a 14.5% dividend increase for 2012/13. Can the company continue to deliver on its 10%-15% growth policy for the next two years? The company's confidence in growing free cash flow is key, so let's see how this and the dividend have progressed since the 2008/09 dividend cut.

As you can see, dividends have been well covered since the 2008/9 cut, the latest payout being just a third of FCF. BT forecasts FCF of 2,300 million pounds for 2013/14 and 2,600 million pounds for 2014/15, so if the board increases the dividend at the top end of its targeted 10%-15% annual growth range, the payout would still be less than 40% of FCF. That looks a decent margin of safety to me, and there appears to be every prospect of BT delivering the intended dividend growth.

Meanwhile, the group has made good progress on supporting the pension scheme and reducing net debt. The pension deficit, which peaked at 9 billion pounds, and net debt, which peaked at 11 billion pounds, currently stand at 5.9 billion pounds and 7.8 billion pounds, respectively. The numbers aren't at all bad for a company with a market capitalization of 25 billion pounds, especially as the adverse effects of quantitative easing on pension schemes should reverse in due course.

Summing up
BT looks well positioned to provide shareholders with the targeted dividend growth for the next two years -- a level of growth that's hard to come by in today's market. At a current share price of 310 pence, new investors could expect a 3.4%-3.5% income for the year ahead with the prospect of that income increasing 10%-15% the following year.

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