Royal Mail (LSE: RMG) shares are at all-time lows. The postal and courier firm, a favourite among some value investors, is looking cheap. But I’m not convinced it’s a good buy for your ISA.
The coronavirus-induced market crash floored the FTSE 250 firm’s share price, at 124p, at the beginning of April. It has since made some gains, but it remains 74% lower than its 2018 peak of 598p. Moreover, 65% of the Royal Mail share price crash occurred in 2018–19, before the pandemic.
Although share price is no substitute for value, a sustained price drop of this size could indicate a struggling company. Despite this, Citigroup has just upgraded Royal Mail’s stock. What prompted this change of view?
Rare double upgrade on Royal Mail shares
Citigroup decided Royal Mail shares are worth a rare double upgrade. This means that their analysts changed the ‘sell’ recommendation to a ‘buy’, bypassing ‘hold’.
Apparently, this bullish decision is because of the soaring number of parcels sent during the coronavirus lockdown period. Royal Mail accounts for about half of all the parcel delivery in the UK. Citigroup analysts believe Royal Mail profits may surge up to 400% higher than currently forecast. This is a huge change, reflecting the firm making the most of short-term opportunities.
Moreover, with Royal Mail shares being battered this year, some analysts believe the group is currently undervalued. Citigroup is giving the stock a fair value of around 210p.
The downsides
Royal Mail stock is beginning to climb. However, I think some of this rise is because of Citi’s upgrade. Indeed, this is one of the problems of buying a stock that’s just been upgraded. The new price already includes the market feeling about the business. It’s likely that Royal Mail stock is already close to being fairly valued.
Moreover, it is not likely that the increased business due to the coronavirus lockdown will be sustained. Prior to this period, pending postal worker strike action and falling volumes in letter delivery was affecting profits.
Royal Mail has recently announced it will be stopping Saturday letter deliveries too. Apparently, staff do not feel adequately protected and have placed pressure on managers to do more to resolve this. Perhaps the decision is justifiable on health grounds or indeed for cost-cutting measures. However, halting the Saturday delivery service may reduce letter volume delivery even further; letters are core business.
In addition, Royal Mail’s dividend yield was looking to be increasingly unsustainable. It sat at just over 15% before the company wisely scrapped it. Although the firm can now claim to have cancelled it in line with other large businesses, it was unaffordable prior to the stock market crash.
Royal Mail stock is currently trading around 173p. This is below Citi’s 210p estimate, which could indicate the firm has more value to provide its investors. However, prospects for Royal Mail’s business were not great before the crash. Royal Mail is struggling with newer and more innovative competitors and persistent threats of staff industrial action. Until it shows it can compete, I will not be buying, despite the low price.
