Royal Mail Group (LSE:RMG) shares continued their upward trajectory last week following the publication of the business’s full-year results. Given the rise, I think it’s fair to say investors were quite impressed. I know I was.
This latest boost has pushed the price of Royal Mail shares up by nearly 60% since the start of the year. And over the last 12 months, the stock has yielded a return of more than 200%. But is it too late to add this business to my portfolio?
What happened to Royal Mail shares?
Looking at the historical price chart for Royal Mail shares, the company had been struggling for several years until recently. This appears to be mainly due to the firm’s over-reliance on delivering letters — something for which the demand has been in decline for quite some time. But over the last 12 months, it has made an impressive recovery. How did it do it?
The management team quickly pivoted to focus more on parcels delivery. Parcels volumes have been steadily rising parallel to the increased adoption of online shopping. The pandemic significantly accelerated this transition. Consequently, for the first time since its inception in 1516, Royal Mail delivered the majority of its revenue through parcels rather than letters in 2020.
As a result, total revenue increased by double-digits for the first time in years. It rose by 16.6% from £10.84bn to £12.64bn. Meanwhile, adjusted operating profits more than doubled from £325m to £702 — a rise of 116%. This surge in capital allowed the management team to substantially pay down its long-term obligations. So net debt also fell from £1.13bn to £457m, with plenty of cash to spare.
Overall, I think the company is in a much stronger financial position and seemingly primed for long-term growth. Therefore seeing Royal Mail shares continue to climb is not all that surprising.
The risks that lie ahead
As promising as this progress is, the parcels delivery market remains highly competitive. Royal Mail may have a size advantage, especially with its established delivery infrastructure network. But with so many rival courier services to fend off, it doesn’t appear to have any tangible pricing power.
Therefore, I believe the leading businesses within this space will be the ones with the greatest level of operational efficiency. Unfortunately, this isn’t something Royal Mail is known for. The management team has begun investing in warehouse automation with its APS system. However, this technology is still being constructed and won’t be usable until 2023. With other courier services already using automation technology, Royal Mail may get left behind, as its shares might.
The bottom line
Despite the rapid price rise of Royal Mail shares, the company still looks relatively cheap, trading at a price-to-earnings ratio of 8.5. And considering the long overdue shift towards parcel delivery services is already beginning to generate substantial profits — despite competitive pressures — I will admit to being cautiously optimistic.
But ultimately, the firm’s economic moat remains quite small. And so, while I do believe the Royal Mail share price can climb higher, I’m not adding it to my portfolio today.
