Royal Mail’s share price is rising. Should I buy the stock now?

The Royal Mail share price is soaring, but are the shares still cheap enough to buy? Roland Head thinks the business still faces some tough challenges.

| More on:

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.

Typical street lined with terraced houses and parked cars

Image source: Getty Images

The Royal Mail (LSE: RMG) share price has risen by 175% since 8 September. That’s when the company said parcel volumes had increased by 34% since the start of the first UK lockdown. The postal operator’s shares are now worth 170% more than they were one year ago.

Positive trading updates in December and early February have strengthened my view that Royal Mail is on track for a recovery. It’s a stock I’ve thought about buying, but I’m a bit surprised by the speed of the share price gains. Have I left it too late to buy the shares — or is there still plenty of runway ahead?

Inflation Is Coming

Inflation is out of control, and people are running scared. But right now there’s one thing we believe Investors should avoid doing at all costs… and that’s doing nothing. That’s why we’ve put together a special report that uncovers 3 of our top UK and US share ideas to try and best hedge against inflation… and better still, we’re giving it away completely FREE today!

Click here to claim your copy now!

Record-breaking numbers

I think it’s worth starting with a look at Royal Mail’s February update, which covers trading during the nine months to 30 December. The group handled a record 496m parcels during the final three months of 2020, as Christmas shopping moved online for most of us.

Parcel volumes have remained high and Royal Mail says it’s kept on 10,000 of the 33,000 temporary workers hired at Christmas. An additional, 6,000 vans have been added to the fleet and temporary parcel centres have been kept open.

Group revenue rose by 30% to £9,312m during the nine-month period, despite a 16% drop in letter revenue. As a result, Royal Mail expects to report an adjusted operating profit of more than £500m for the year ending 31 March.

I’m not surprised Royal Mail’s share price has rallied. But, as a potential buyer, I need to look ahead. Are the shares still cheap based on their growth potential?

What happens next?

I think it’s safe to assume parcel volumes will continue to rise over the next few years. But I don’t expect to see a repeat of the kind of growth seen during the pandemic.

The good news is that Royal Mail’s main union has agreed to support the changes needed to shift the group’s focus from letters to parcels. This will include new measures such as parcel-only hubs and dedicated parcel delivery vans.

I’m pleased with this news. What worries me is that these changes could take longer to deliver and cost more than expected.

The reality is that Royal Mail’s core UK business isn’t very profitable. Last year, the group’s GLS parcels business generated 64% of adjusted profits. My analysis suggests the results will be similar this year, even though GLS revenue is only half that of Royal Mail.

Press reports have suggested GLS could be sold. This would provide funds for modernising Royal Mail. However, I think selling GLS would also reveal the weak profitability of the core UK business. I’m not sure if I’d want to own shares in Royal Mail without GLS.

Royal Mail share price: what I’m going to do

The stock’s recovery has taken Royal Mail’s share price back to where it was in September 2018. Looking ahead, analysts expect earnings growth to continue over the coming year. Their estimates value the shares at about 13 times forecast earnings, with a possible dividend yield of 2.8%.

That may seem like good value at first glance, but I’m not convinced. In my view, Royal Mail still has a lot to prove. I see the shares as fair value at the moment, but that’s not enough to convince me to buy.

More on Investing Articles

Passive and Active: text from letters of the wooden alphabet on a green chalk board
Investing Articles

2 undervalued passive income stocks I’d buy today with £1,000

Falling stock prices are pushing up dividend yields. As a result, our author is looking for undervalued passive income stocks…

Read more »

Close-up of British bank notes
Investing Articles

2 cheap dividend shares I’d buy in a heartbeat

Our writer picks a pair of FTSE 100 dividend shares he would consider for his portfolio, that he thinks look…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

With £500, I’d use the Warren Buffett method to find cheap shares

The legendary investor Warren Buffett has become a billionaire by following some key investment principles. Our writer explains why he…

Read more »

Man in a clothing store in a medical mask because of a coronovirus.
Investing Articles

Down 81%, are boohoo shares set for an explosive comeback?

boohoo shares have been falling rapidly. But could interest from a billion-dollar hedge fund cause a turnaround in 2022?

Read more »

Smartly dressed middle-aged black gentleman working at his desk
Investing Articles

The Tullow Oil (TLW) share price jumps after losses! Is now the time to buy?

The Tullow Oil (TLW) share price ticked upwards on Thursday morning after falling nearly 30% over the last month. So,…

Read more »

Female analyst sat at desk looking at pie charts on paper
Investing Articles

Is the Lloyds share price about to dip below 40p?

The Lloyds share price has been trading below 50p for the better part of the year. But could the stock…

Read more »

Cheerful young businesspeople with laptop working in office
Investing Articles

2 beaten-down FTSE 250 shares I’m buying and holding for the long term

Andrew Woods explains why he's adding two FTSE 250 shares to his portfolio in the middle of a market sell-off.

Read more »

Female analyst sat at desk looking at pie charts on paper
Investing Articles

The Legal & General (LGEN) share price jumps 3%! Am I too late to buy?

The Legal & General (LGEN) share price soared in early trading on Thursday as the company registered a good start…

Read more »