Over the past 12 months, Royal Mail (LSE: RMG) shares have returned 184%, excluding dividends. However, in the past few weeks, the stock’s upward trend has gone into reverse.
Ever since it jumped above the fundamentally important 600p level at the beginning of June, shares in the delivery giant have been in retreat. The stock is off around 18% since reaching this multi-year high.
Over the past 18 months, I’ve been watching Royal Mail shares. At times they’ve looked quite expensive, but on other occasions, I’ve thought the stock looked cheap compared to the company’s potential.
After recent declines, I think shares in the company are starting to look appealing again, from a valuation perspective.
The valuation of Royal Mail shares
Over the past 18 months, the group’s achieved windfall profits. The number of consumers using the company’s services to ship parcels around the country has surged, and management plans to spend this windfall on modernising the business.
This spending will hit profitability in the near term. Nevertheless, I think these efforts should help improve the group’s efficiency, profit margins, and long-term outlook.
This higher level of spending seems to be one of the reasons why investors have been selling Royal Mail shares recently. But I reckon this could be an opportunity for long-term investors.
Based on City analysts’ current figures, the group will earn roughly the same level of income in its current financial year as 2021. Modest growth is also pencilled in for 2023.
Based on these projections, Royal Mail shares are selling at a forward price-to-earnings (P/E) ratio for 2023 of just 8.1. What’s more, City analysts expect the company’s dividend to more than double over the next two years. If it hits these projections, the firm will be paying out 23p per share, giving a yield of 4.6% on the stock.
Projecting growth
Of course, these are just projections, but I think they show the group’s potential. As spending on capital equipment falls away over the next few years, the group will be able to return more cash to investors.
Further, as the City’s figures show, profits aren’t actually expected to decline over the next few years. Profit growth will moderate from last year’s levels, but Royal Mail is still set to earn £635m in 2023. That’s compared to £620m in fiscal 2021.
I think these figures illustrate the value on offer with Royal Mail shares. Still, they should only be used as a guide.
Multiple factors could destabilise the group’s growth in the years ahead. Capital spending projects could overrun or cost more than projected. The company could also encounter labour disputes, and inflation may push costs up, significantly impacting profit margins.
Even after taking these potential risks into account, I think Royal Mail shares offer value. As such, I’d buy the stock for my portfolio today as a value and growth investment.
