Are Royal Mail shares a brilliant buy after the correction?

Royal Mail shares crashed after a brief rally. Are they worth buying at a discount right now? Anna Sokolidou thinks she knows the answer.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

I always advocate investing after a correction. This seems to be exactly the situation with Royal Mail (LSE:RMG) shares, which plunged somewhat after the wild August rally. But are the shares now a buy or a value trap? Let’s have a look.

Royal Mail share price

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Source: Google Finance

The rally in the middle of August could have been due to the overall optimism of Footsie investors. However, the Royal Mail stock outperformed the broader index. It climbed from around 180p to 217p in less than a week. But as of the time of writing, the shares are trading for around 172p. 

So, what does the future have in store for Royal Mail? Well, Goldman Sachs, one of the largest investment banks in the world, predicts a share price of 230p. But do the fundamentals signal a strong buy?

Royal Mail fundamentals

My colleague Edward Sheldon wrote a wonderful article on the company’s earnings results. No doubt, they were quite discouraging. Royal Mail was definitely among the companies to suffer from Covid-19. One of the reasons was the substantial decline in the volume of letters sent. But after having studied the company’s results in a bit more detail, I realised there was also a one-time factor. Royal Mail is enjoying higher demand for parcel deliveries with all this internet shopping we are doing. Here’s an excerpt from the financial report: “Parcel volumes up 2 per cent, lower than expected, due to threat of industrial action (Q3) and impact of COVID-19 on international import volumes (Q4). Parcel revenue up 4.6 per cent, due to targeted pricing actions“.

All that doesn’t look nice. But it seems to me that the threat of industrial action was rather a one-off. So, the next time the company reports earnings, we will see a rise in the revenue from parcels delivered, I think. Although many coronavirus-related restrictions were cancelled, it looks like many lockdown habits are here to stay. People still like to order online. This means that Royal Mail’s customer behaviour patterns will probably stay unchanged for a while. But it also looks like the lower revenue streams from letter deliveries are also here to stay.

The company’s management admits Royal Mail is unlikely to be profitable in 2020–21. What’s more, its shareholders won’t receive any dividends. But the management took very important steps to increase efficiency. First, it adjusted the working process in a way to cope with the coronavirus reality we are in, including social distancing measures. But most importantly, the company took steps to get “leaner and fitter“. Not only does Royal Mail plan to make some of its non-functional higher level employees redundant, it’s also going to cut its capital expenditure. Although job losses always have bad social consequences, these cost reductions are clearly positive for Royal Mail’s financial health. On top of that, its cash pile totals £1.9bn, which management predicts will still be large in 2020–21.  

Here’s what I’d do

Although Royal Mail is clearly a large company with a brilliant past, I wouldn’t buy its shares just yet. I think an investor has to be patient and indifferent to market moves in order to buy the stock. In my view, a defensive investor would be far better off picking shares from The Motley Fool’s epic catalogue of exclusive reports. 

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Anna Sokolidou has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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