When I look at the indicators for quality, value and momentum, Royal Mail (LSE: RMG) is flashing ‘buy me’ like a bright neon sign. How the company’s fortunes have changed since the almost universally negative media coverage of the stock from around a couple of years ago.
Is Royal Mail one of the best shares to buy now?
Back then, the business was dogged by poor industrial relations with its workforce, shrinking profits, rising costs and difficult market dynamics. The letter post business was in serious decline. And the parcel post operation looked to me like a poor, low-margin alternative. I didn’t see much potential for a turnaround at Royal Mail.
But there has been a turnaround. And it’s remarkable because even that most seasoned of successful investors, Warren Buffett, tends to avoid potential turnaround situations. In 1979, for example, he wrote: “Both our operating and investment experience cause us to conclude that turnarounds seldom turn.”
Mentally, I wrote off the stock around the time of my previous article about the company in 2019. However, some prescient investors called the turn in the company’s fortunes. For example, Motley Fool writers Manika Premsingh and Roland Head went against the crowd near the stock’s lows and suggested it could be a decent ‘buy’.
It’s clear the cheap valuation back then was a big influencer for those investors. But they also sniffed out the potential for a turnaround in the company’s fortunes. And some institutions started buying too. For example, RWC Asset Management established a new notifiable position in the shares around 10 January 2020. And Vesa Equity Investments increased its holding around 1 May 2020, and has added more stock to its portfolio since.
Improving news flow
The company news flow began to get better. There was progress regarding industrial relations, a new CEO, and the execution of the restructuring and cost-control programme. But a big factor in Royal Mail’s improving performance has been the coronavirus pandemic, which pushed up demand for parcel post. Earnings rebounded in the trading year to 2021 and the share price shot up. From its coronavirus low around the end of March near 125p, the stock has risen to today’s price of around 580p.
However, my assumption is the fast gains from the share price are now behind us. City analysts expect earnings to dip by three or four per cent in the current trading year and to recover that lost ground the following year to March 2023. In other words, earnings will likely be essentially flat. But, of course, those analysts could be wrong and Royal Mail may surprise again and deliver meaningful growth in earnings.
Nevertheless, I’m not tempted to buy the stock now for growth in earnings. And, despite the company maintaining its shareholder dividend payments, I’m not attracted to the company as an income share. If the business makes the 24p per share payment predicted for the full year to March 2023, the dividend will be back to 2018 levels.
Meanwhile, the forward-looking yield works out at about 4%. However, Royal Mail’s business remains lower margin. And I’d rather seek out my long-term investments from sectors with more robust economics.
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Kevin Godbold 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.