The Royal Mail (LSE: RMG) share price has fallen by 60% over the last year. Are the shares now too cheap to ignore, or is this a business with deep-rooted problems?
I’ve been taking a closer look at last week’s results. In this article I’ll give my verdict on this 500-year-old business.
Not a great year
The firm’s performance during the 2018/19 financial year wasn’t that great. Although adjusted revenue rose by 2% to £10,581m, operating profit fell by 34% to £376m. The firm’s adjusted operating margin dropped from 5.7% to 3.6%.
Profits are clearly moving in the wrong direction. So what is chief executive Rico Back planning to do?
Two big changes
One change that shareholders will notice is that the dividend will be cut to 15p from this year. This is a change I support — the previous 25p payout was not affordable, in my view.
A cut was needed to free up cash for investment in the next stage of the company’s evolution. This will involve £1.8bn of new investment aimed at improving and expanding the firm’s parcel service.
This is important, because the firm expects the number of letters it handles to fall by about 26% over the next five years. Without significant growth in parcels, Royal Mail’s UK-wide network will be struggling to cover its costs.
By contrast, the parcels market is growing as more of us shop online. Mr Back is hoping to increase parcel volumes by 4% to 5% next year. The firm says this would represent an increase in market share, which I see as a vital element for a successful turnaround.
Gig economy vs unions
One of the firm’s key assumptions for the next five years is that the unions which represent its workforce will help to “deliver the change in a collaborative manner”.
Royal Mail’s industrial relations haven’t always been easy. Although this isn’t the place for a political discussion, I think it’s fair to say that many competing courier firms have an in-built cost advantage over Royal Mail, thanks to their use of non-union and self-employed workers.
Another of Royal Mail’s big costs is its physical network of post boxes and local sorting offices. I see this as an asset too — no other company has this kind of physical presence. But there’s no doubt that making a profit from this network requires high volumes and some restructuring to reflect the shift from letters to parcels.
Buy, sell or hold?
Chief executive Mr Back is targeting a five-year turnaround. This should restore Royal Mail’s profit margins to 5% and reshape its network to support parcel-led growth.
Further cost savings will be needed. Hitting these targets while keeping the company’s powerful unions on side won’t be easy. But in my view, this plan has two big advantages — it’s the only sensible choice and it should be supported by long-term growth in parcel volumes.
Is this the right time to buy the shares? The company’s £2bn market cap means the shares trade at a 45% discount to the group’s net tangible asset value of £3.6bn. This includes a £2bn property portfolio.
Profit forecasts suggest the shares could be cheap too. Royal Mail now trades on about eight times forecast earnings, with a 7% dividend yield after this year’s cut.
There’s a long road ahead, but I feel these shares could reward patient investors.
