Royal Mail (LSE:RMG) is struggling now like many other businesses due to the coronavirus crisis. It even had to make some of its employees redundant. Is the company’s stock a bargain or a value trap now?
Royal Mail’s job cuts
The truth is that the company’s problems started long before the coronavirus pandemic. As we all know, due to the widespread use of the Internet, people send fewer letters. But Covid-19 made matters even worse. According to the company’s representative, the Covid-19 lockdown led to a dramatic fall in the number of letters sent. However, many more people began sending parcels, which prevented things from getting too bad.
In order to improve the situation, the Royal Mail decided to cut 2,000 management positions. This would lead to cost savings of £130m. But the job cuts will not be made straight away. Instead, the company aims to make 2,000 middle-managers redundant by March 2021. So, these economies will not be felt immediately.
Financial fundamentals
These redundancies are not the only way the management plans to get “leaner and fitter” though. Over the next two years, Royal Mail will reduce its capital expenditure by £300m. All these measures are quite positive changes to the company’s liquidity and profitability, I think.
Royal Mail barely managed to make a profit this year. Although revenue increased this year (it was £10.84bn in 2020 as opposed to £10.44bn in 2019), total operating profit fell by 13.6%. The plunge in basic earnings per share was even worse, falling almost 56% from 30.5p to 19.6p. As a result, the efficiency figures are quite discouraging. The net profit margin now stands at just 1%, whereas the return on equity (ROE) is 3%.
However, the company’s shares are trading at pretty undemanding valuations. If we take Royal Mail’s current share price and divide this figure by the earnings per share, we’ll get the price-to-earnings (PE) ratio of less than 9. This is quite cheap on its own. But it seems that the company’s earnings will still stay under pressure due to social distancing measures and similar coronavirus-related costs. The actions recently taken by the management might imporove efficiency. But investors need a lot of patience to see this happen.
Equally unpleasant is the fact that shareholders will not receive any dividends for a year. Although management expects to re-commence paying them in 2021–22, you should remember that CEOs tend to be rather optimistic.
Most importantly, now the company faces quite a big challenge – it has to move away from the letters business and start specialising in parcels, since there is no reasonable consumer demand for the latter. At the same time, as my colleague James mentioned, there is quite a lot of competition in this area. Many businesses have already adapted to the new reality of online shopping and deliveries.
Now what?
Although Royal Mail is an old and established company, it is going through hard times. I would only recommend these shares to patient investors who are willing to take on some additional risks. In the UK there are many other opportunities for value investors, I think.
