The Royal Mail (LSE: RMG) share price soared around 50% in 2021, making it one of the top performers in the FTSE 100. This was partly due to the boom in online shopping deliveries over the past year. As such, on the back of an excellent 2021, can the shares rise further in 2022, or will they see a decline?
Tremendous recent performance
In the first half of its FY21/22 financial year, Royal Mail’s performance has been excellent. Indeed, while revenues only rose 7% year-on-year, operating profits reached £311m. This is compared to an operating loss of £20m the year before, which was caused by restructuring charges and negative impacts from the pandemic. As such, the company’s recovery has clearly been very strong.
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This has also allowed it to return a significant amount of money to shareholders, including an interim dividend of 6.7p and a special dividend of 20p per share. The firm also announced a share buyback programme of £200m, demonstrating its strong financial position. As such, the recent rise in the Royal Mail share price seems justified to me. A similar performance next year could see it rise even further.
Is the share price undervalued?
From a purely valuation perspective, the Royal Mail share price does look fairly cheap. Indeed, the group reported basic earnings per share of 27p in the first half of the year, and if it can perform in a similar way in the second half of the year, this would give the shares a price-to-earnings ratio of under 10. This illustrates that they may be too cheap and have space to rise in 2021.
It’s also important to consider GLS, Royal Mail’s subsidiary, when valuing the company. This is the company’s international business, which covers both North Europe and North America. While GLS produces far less revenue than Royal Mail, its profitability is around the same. The company also estimates that GLS operating profits will total around €500m in FY24/25. As such, this business could be a key driving factor for the Royal Mail share price.
Nonetheless, there are some factors that may hold the shares back. For one, wage inflation is a very large problem for Royal Mail, because around half the company’s operating costs are staff costs. There are also some barriers to its modernisation programme. This is due to pressure from trade unions, which have in the past blocked Royal Mail from cutting costs. This included preventing the company from making any compulsory redundancies. These factors may see operating profits decrease over the next few years.
What am I doing?
Despite these risks, I still believe that the Royal Mail share price has upside potential heading into 2022. The pandemic seems to have quickened the transition into e-commerce, and this should benefit Royal Mail and other delivery companies.
Despite the hurdles posed by trade unions, a modernisation programme is still in process. This is expected to lead to around £100m in annual savings. This should help offset any additional costs caused by wage inflation. Therefore, while I don’t think the company can replicate its 2021 performance, there still seems to be space to rise next year. Therefore, I may buy some Royal Mail shares.
