The Royal Mail (LSE: RMG) share price enjoyed a strong recovery from the pandemic, as e-commerce soared. This meant that the company’s revenues from its parcel business reached new highs, including its subsidiary GLS. But over the past few months, the Royal Mail share price has plunged around 30%, mainly due to inflationary pressures and slightly reduced parcel demand. Does this make now a great time to buy on the dip or is this a FTSE 100 stock I should leave on the sidelines?
Recent results
The recent Q3 results were a mixed bag. From a positive standpoint, the company’s guidance remained unchanged, and it expects around £500m adjusted operating profit for FY21/22. In addition, the performance of European subsidiary GLS continues to impress. In fact, in euro terms, it expects 9% revenue growth, and operating profit margins of around 8%.
On the other hand, there were some key worries to point out, and it’s these factors that have caused the Royal Mail share price to drop. Firstly, there were some signs that demand for parcels was starting to wane, in comparison to pandemic levels. Indeed, in the third quarter, parcel volumes declined 7% year-on-year, and parcel revenues declined 4.9%. Any decline is clearly not good news for the company, even though parcel demand remains higher than pre-pandemic.
Secondly, costs at the company are soaring. For example, in January around 12% of the workforce was off sick. This meant that the company has had to spend more on overtime, additional temporary staffing, and sick pay. Year-to-date, this has cost it around £340m. As such, there’s a risk that profit margins will be strained.
Rising inflation is also likely to lead to higher wages, which is one of Royal Mail’s main costs. The strength of the Communication Workers Union may be a key factor here. A strong trade union may mean management has to concede more than its rivals need to. Plus, management-worker relations have often been difficult at the firm. This is another factor that may strain profits for the group.
Is the Royal Mail share price too cheap?
From a valuation viewpoint, the Royal Mail share price does seem far too cheap to me. In fact, it has a price-to-earnings ratio of just 4.5, which is far lower than the average P/E ratio among FTSE 100 stocks of around 15. In addition, its price-to-sales ratio is just 0.3, once again far lower than the average FTSE 100 stock.
Such low valuations lead me to believe that Royal Mail shares are now far too cheap. Although there’s a risk that profits may fall slightly this year, it already seems factored in to the company’s valuation. The presence of GLS, which is seeing consistent growth year-on-year, offers another compelling for me reason to buy shares. Therefore, this is a stock I’m very tempted to add to my own portfolio.
