Last year, Royal Mail (LSE: RMG) shares charged higher as the company benefited from a boom in parcel delivery volumes. However, over the past few months, the stock has come off the boil. Investors have started to avoid the business as growth has slowed.
This presents an interesting dilemma. While Royal Mail has undergone a significant transformation over the past 24 months, the company’s growth is likely to slow as we advance. This may lead the market to re-evaluate the business and push the stock lower as a result.
The question I want to know the answer to is, could it be worth taking advantage of recent declines to buy Royal Mail shares?
Company under pressure
Over the past 12 months, shares in Royal Mail have added 160%. Unfortunately, since the beginning of June, the stock is off around 17%.
The sell-off in the company’s shares accelerated after it published its latest trading update towards the end of July. This was broadly positive, but one number stuck out. Parcel volumes declined 13% year-on-year in the fiscal first quarter.
Still, volumes were 19% ahead of pre-pandemic levels and parcel revenue increased 3.4% year-on-year overall. However, it suggests some of the growth the company experienced last year may not be sustainable. And that seems to me to be the reason why the market has been dumping Royal Mail shares recently.
Another factor is the company’s own forecast that it will be spending £400m over the next year in the UK alone on capital projects. That is a big chunk of cash. The spending will almost certainly have an impact on profit margins and the group’s balance sheet.
The outlook for Royal Mail shares
In the middle of last year, I turned positive on the stock as it became clear that the group was benefitting from a surge in parcel delivery volumes. I changed my opinion earlier this year when the economy started to reopen.
As the economy reopened, I thought e-commerce demand would decline, and consumers would be able to deliver personal packages, such as birthday gifts, in person.
Initial indications appear to show this is just what’s happened. As such, it seems to me that the business and the stock have both entered a consolidation phase. Royal Mail is using its windfall profits from 2020 to reinvest in the business. At the same time, organic growth has slowed.
In the long run, as the e-commerce market continues to grow, I think the demand for the company’s parcel services will only expand. Nevertheless, we could see some uncertainty and volatility in the near term.
Therefore, while I’m optimistic about the long-term outlook for Royal Mail shares, I wouldn’t buy the stock today. I want to see how the company performs in the next year or so, and navigates its current challenges before initiating a position. I think the stock has passed its peak for now, although it could return to previous highs in the future.
