How Will Royal Mail Plc Fare In 2014?

Should I invest in Royal Mail PLC (LON: RMG) for 2014 and beyond?

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For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.

That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.

To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:

  • Prospects;
  • Risks;
  • Valuation.

Today, I’m looking at postal and delivery service provider Royal Mail (LSE: RMG).

Track record

With the shares at 572p, Royal Mail’s market cap. is £5,710 million.

This table summarises the firm’s recent financial record:

Year to March 2012 2013
Revenue (£m) 8,764 9,279
Net cash from operations (£m) 301 761
Pre-tax profit (£) 201 324

1) Prospects

With letter-post volumes continuing to shrink, parcel volumes are increasingly important to Royal Mail and now account for around 51% of the firm’s revenue. That’s a salient point to appreciate if considering an investment in the company, as the future looks set to be all about parcel delivery, which is a crowded market just about everywhere. In a recent update, Royal Mail reported flat parcel volumes for the nine months ending in December, although revenue was up 8% on a like-for-like basis thanks to a change to size-based pricing.

So, just as Royal Mail’s traditional monopoly positioning in the UK’s postal spectrum ebbs away, the firm is also cast adrift from the protection and financial cushioning of state ownership to steam under its own power in the unforgiving competitive waters of the private sector as a public limited company — no wonder the firm has been engaged in what it calls a ‘transformation programme’, designed to streamline the organisation and drag it kicking and screaming into a world of new realities.

Such root-and-branch reform, involving investment in systems and equipment, operational streamlining, and management shake-ups, is never easy and the firm acknowledges “This wide-ranging programme requires difficult change for our people.” Inevitably, when the landscape shifts dramatically after a long period of being the same, as in an earthquake, the people in that landscape will be unsettled. In that vein, it’s encouraging to learn that the firm has arrived at an agreement-in-principle with its workers’ union, the CWU, involving an agenda for growth, industrial stability and protections, a three-year pay offer, and pensions reform. We’ll find out whether it all goes through around 5 February after the firm’s employees complete their ballot.  

It felt weird writing that last paragraph, as if I was discussing a company back in the seventies. But that underlines the importance of the issue, to my mind. The success of an investment in Royal Mail for 2014 and beyond hinges on the success of the transformation programme, and how well it engages the hearts and minds of the firm’s workforce.  

2) Risks

The biggest risk to an investment here is that more industrial action manifests down the line. Royal Mail hasn’t lost all its advantage, it still has a comprehensive network and the trust of business and public alike, which sees it delivering more parcels than any near rival. However, if industrial action interrupts the service too often, customers will place their loyalty elsewhere. In a worst-case scenario, Royal Mail could gradually see its market share eroded by competition, shareholders could see their investment shrink, and employees could see their own actions destroying their own job security. Such an outcome has certainly occurred in other industries.

3) Valuation

Looking forward to year ending March 2016, city analysts predict earnings covering the dividend about 1.8 times, with the payout yielding around 4.8% at today’s share price.

You can buy into that potential income-stream for a forward P/E multiple of just over 11, which compares well to earnings’ growth expectations of 14% that year and that dividend yield.

What now?

Royal Mail strikes me as being a potentially decent income play, but it does need to transform its culture and operations successfully to compete, thrive and even to survive. I think it probably will and I’m happy to watch the firm for a bargain entry point.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Kevin does not own any Royal Mail shares.

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