What are the characteristics that define great income shares? I would say steady revenue growth, consistent profitability, a wide moat to entry and, of course, chunky dividends that are well covered by earnings. First half results from Royal Mail Group (LSE: RMG) confirm that the company ticks each of those boxes, making the shares’ 4.5% yielding dividend mightily attractive.
Revenue growth in the six months through September was a fairly negligible 1%. But considering the volume of letters posted continues to fall by 4% per year, broadly flat revenue should be cheered. How did revenue rise despite fewer letters being posted? E-commerce. Everything we buy online needs to be shipped and Royal Mail, as the largest player in the market, has benefitted greatly from this.
In H1, parcel volume rose 2% year-on-year and revenue from these packages a full 3%. Aside from growing in line with the market, there’s also plenty of potential in Royal Mail’s European GLS parcel shipping business. This service grew revenue by 9% and operating profits by 25% year-on-year in H1 and it has plenty of room to grow in the fragmented markets it serves. The combination of slow and steady growth in the core UK market alongside good growth opportunities in Europe offer shareholders lots of upside along with considerable downside protection, exactly the qualities income shares should have.
And as for profits
Revenue growth is great but an income share also needs profit growth to fund shareholder payouts. What’s Royal Mail’s performance like in this regard? Well, unfortunately pre-transformation cost operating profits fell 5% year-on-year as price competition and new legislation took their toll.
However, the company is confident that after several years of heavy investment in infrastructure it’s past the peak investment period. This will mean investment capex coming down from £615m a year to £500m a year. Combined with a targeted £600m reduction in operating costs over the next three years and analysts’ forecasts of small earnings increases are readily achievable.
Royal Mail will also need to stave off competitors as the rapidly growing parcel delivery sector attracts attention from newcomers. The good news is a strong pre-existing embedded presence mean Royal Mail still has over 50% market share measured by volume. And the company’s £1.8bn of investments over the past three years in improving handling, sorting and delivery infrastructure is geared towards maintaining and improving this edge. The success of this endeavour will be a critical concern for investors to watch in the coming years, but Royal Mail’s deep pockets and competitive advantages should stand it in good stead.
What does all this mean for dividends? Management felt comfortable raising interim dividends by 0.4p to 7.4p in H1. A similar bump up in the second half would see full-year payouts reach just shy of 23p per share. At current share prices this would be a yield of 4.8%. Investors likely won’t see significant share price appreciation in the future, but those looking for stability and steady income potential would do well to consider Royal Mail.
