Is Royal Mail PLC Dependent On Debt?

Are debt levels at Royal Mail PLC (LON: RMG) becoming unaffordable and detrimental to the company’s future prospects?

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royal mail

Since listing on the stock market in October, Royal Mail (LSE: RMG) has delivered share price gains of 82%. This handsomely beats the performance of the FTSE over the same period, which has posted gains of just 5%.

Indeed, the outperformance has not slowed in 2014, with Royal Mail beating the wider index year-to-date, too (Royal Mail is up 5% while the FTSE 100 is up 1%), as its dividend proves to be popular with investors.

However, is the financial stability of Royal Mail being overlooked just because the company pays a generous dividend? Furthermore, is Royal Mail dependent on debt to meet its relatively large dividend commitment and transition the business towards parcels and away from letters?

Excessive Debt

With a debt to equity ratio of 91%, Royal Mail is clearly using a significant amount of debt to fund investment and maximise returns to shareholders. This means that for every £1 of net assets, Royal Mail currently has £0.91 of debt. While such a ratio is not excessive, it is moderately high, although Royal Mail is arguably more stable than many of its FTSE 100 peers and so is able to live with higher debt levels than the average FTSE 100 company.

Further evidence of Royal Mail’s debt levels being manageable can be seen in the interest coverage ratio, which stands at a healthy 4.8. This means that Royal Mail was able to make its net interest payments nearly five times in its most recent financial year, which highlights that the business currently has sufficient headroom when servicing its debt. As a result, debt levels appear to be sensible and could be increased somewhat, should Royal Mail wish to improve returns to shareholders or increase investment in the business.

Looking Ahead

As mentioned, Royal Mail pays a generous dividend, with shares currently yielding 2.7%. This may not sound much but shares have risen by 82% since October and, moreover, are expected to increase dividends (on a per share basis) by 30% per annum over the next two years. This means that, unless shares continue to rise at a meteoric rate, Royal Mail’s yield should improve over the next two years.

Therefore, with an impressive dividend growth rate and financial gearing levels that appear to be manageable, Royal Mail could continue to beat the market during the rest of 2014.

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.

> Peter does not own shares in Royal Mail.

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