Royal Mail shares have crashed 20% in 2022! Is this a bargain or a trap?

Royal Mail shares crashed in January after management cut guidance, but is this actually a buying opportunity? Zaven Boyrazian investigates.

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Shares of Royal Mail (LSE:RMG) haven’t had a great run in 2022, so far. Despite delivering record growth throughout 2020 and 2021, this business has taken a bit of a tumble. But is this a sign of trouble ahead or a buying opportunity for my portfolio? Let’s explore.

Investigating the Royal Mail shares performance

The recent tumble came on the back of delivery delays as well as a mixed third-quarter trading update. On the one hand, domestic parcel revenue between October and December 2021 continued to surge by an impressive 43.9% versus pre-pandemic levels. On the other, it came in 4.9% lower than a year ago. However, I’m not too surprised, since 2020 was an exceptional year for e-commerce.

At the same time, performance from its GLS division continued to expand with a 5% increase in parcel volumes reaching 239 million during the quarter.

Unfortunately, this wasn’t enough to replace the 2020 surge in sales. And consequently, total revenue actually fell 2.4%. But again, it’s still 17.1% higher than pre-pandemic levels.

Meanwhile, the leadership team continues to restructure and streamline the business. It has announced plans to axe 700 managerial positions through the company. While this is undoubtedly unpleasant for the soon-to-be ex-employees, the move is expected to deliver £40m in annualised savings from 2023 onwards.

However, the cost of sacking a large number of employees is high – £70m in this case. And consequently, the business cut operating profit guidance from £500m to £430m. Needless to say, with revenue growth stagnating and forecasts being cut, the fall of Royal Mail shares is hardly a surprise.

A trap or buying opportunity?

Analysts from JP Morgan Cazenove recently cut their price forecast for Royal Mail shares by 7%. In fact, this appears to have been what triggered the start of the stock’s decline last month. Yet, even after the reduction, the target price is still 768p. By comparison, shares of Royal Mail are currently trading at around 444p, suggesting the market may have overacted to the news.

That certainly seems like a buying opportunity in my mind, especially considering the stock is currently trading at a price-to-earnings ratio of 5.1!

But as cheap as that seems, I have some concerns. With the cost of living on the rise, due to inflation, higher energy prices, and a national insurance tax hike, consumer spending could soon take a significant hit.

And as households aim to cut unnecessary costs, the volume of e-commerce orders could fall. That means fewer parcels to deliver and, in turn, less revenue for Royal Mail.

Personally, I think there are quite a few unknowns about the operating environment Royal Mail is entering. What’s more, these threats are largely out of management’s control – a bad trait in my experience. That’s why I see it as a trap rather than a bargain. And it’s why I’m not going to be adding any shares to my portfolio today, despite the seemingly low price.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Zaven Boyrazian 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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