Can the Royal Mail share price keep pushing higher?

Rupert Hargreaves explains why he thinks the Royal Mail share price is undervalued as earnings continue to expand at the delivery group.

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The Royal Mail (LSE: RMG) share price has outperformed all of my expectations over the past two years. Throughout 2019, the company was struggling with high costs and poor productivity. Then, as the pandemic started at the beginning of 2020, it looked as if the business would buckle under staff absences and rising demand.

However, the corporation rose to the challenge. By the end of the year, it was reporting increasing sales and improving profitability.

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This trend continued throughout 2021. The booming e-commerce market, and rising demand for parcel shipments, coupled with the company’s own efficiency efforts, pushed profits higher. The stock followed suit, reaching a near all-time high of 600p in the middle of the year.

Unfortunately, after hitting this level, the Royal Mail share price has struggled to maintain its positive performance. The stock has dropped 5% over the past six months. But it remains 28% higher over the past 12 months (excluding dividends). 

Despite this performance, it looks to me as if the stock can continue to push higher as its fundamentals improve

Royal Mail share price outlook

Like many other London-listed businesses, the postal and delivery company is having to deal with some significant challenges. These include a high number of staff absences due to coronavirus restrictions, rising prices as inflation bites, and surging demand for its services.

While high demand is an excellent problem to have, trying to navigate this with a high level of staff absences is causing issues. These are the biggest challenges the company faces right now, and they could upset growth in the year ahead. 

Nevertheless, assuming the business can rise to meet the challenge of booming demand, City analysts are forecasting big things from the firm this year. According to current projections, analysts believe the group will report earnings per share of 62p this year, up around 8% year-on-year. They are also forecasting earnings of 63p per share for 2023. 

The stock is currently trading at a forward price-to-earnings (P/E) multiple of just eight based on these metrics. To put this number into perspective, the five-year average P/E of the Royal Mail share price is around 10. 

Undervalued

As such, it seems as if the stock is undervalued by around 25% at current levels. Although there is no guarantee the stock will return to its long-term average valuation. 

On top of this attractive valuation, analysts also believe the shares will yield 5% this year. This is above the market average of around 3.8%. 

Considering all of the above, it looks to me as if the Royal Mail share price has the potential to keep moving higher. Not only does the stock look cheap, but there are also a couple of substantial tailwinds that can drive earnings higher in the medium term. As earnings expand, I believe market sentiment towards the business when improved. 

As such, I would be happy to buy the stock for my portfolio as a growth and income play 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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