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Should I buy Royal Mail shares?

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I’ve been a fan of Royal Mail (LSE: RMG) shares for much of the past year, impressed by the company’s transformation, use of new technology and growth initiatives. These changes have helped the group capitalise on the booming e-commerce market and increasing demand for parcel deliveries. 

Unfortunately, after a record-breaking 2020,  demand for the company’s services is starting to slow as the economy reopens. And as the firm’s outlook has begun to dim, investors have moved away from Royal Mail shares. 

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I’m always interested in companies that fall out of favour with the rest of the market. It’s often the case that these equities fall too far and become undervalued. 

So, as shares in the business have been falling, I’ve been taking a closer look at Royal Mail to see if it could be worth adding the stock to my portfolio. 

Time to buy Royal Mail shares?

Earlier this year, alongside its results for 2020, Royal Mail warned it was facing an uncertain outlook. Despite its impressive performance throughout the pandemic, management noted the favourable environment would be unlikely to last forever. 

That’s just what has happened. As the economy has reopened, parcel volumes have declined. In a trading update issue ahead of the company’s annual general meeting, Royal Mail notes parcel volumes fell 13% year-on-year during the three months to the end of June. However, rising letter volumes have offset some of this decline, jumping 22% year-on-year. 

Overall, group revenue for the three months to the end of June rose 12.2% year-on-year and 13.4% compared to the same period a year ago. I think these figures show that while the company is facing some challenges, it continues to grow. 

Therefore, while I’ve expressed concern about Royal Mail’s growth potential in the past, I’m now starting to change my view. Based on current growth trends, analysts expect the company to report earnings for the year of 57.6p. That’s about the same as last year, which suggests the growth achieved during the pandemic is here to stay. 

Based on these earnings targets, the stock is trading at a forward price-to-earnings (P/E) multiple of 9.2. I think this undervalues the stock’s potential. 

Risks and challenges 

That said, there are plenty of risks bearing down on Royal Mail shares at present. The company has to fight off numerous competitors, some of which have much deeper pockets and the ability to pick and choose their operating markets. These competitors could hurt the business’s growth. 

Moreover, group operations could be at risk from another wave of coronavirus. Another outbreak could dramatically change the company’s earnings potential. 

Still, despite these risks and challenges, the company’s recent positive trading update is encouraging. That’s why I’ve decided to change my view on the business and would buy Royal Mail shares for my portfolio today. 

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Rupert Hargreaves 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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