Should I buy cheap Royal Mail shares?

With low P/E ratios, could Royal Mail shares be a good investment as revenues remain high after the pandemic?

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As a postal and logistics company, Royal Mail Group (LSE:RMG) owns a number of well-known brands, including Parcelforce Worldwide. Now that Royal Mail shares are down 26% over the past three months, is it a good time to add this firm to my long-term portfolio? What’s more, is the share price cheap? It currently trades at 318p. Let’s take a closer look. 

Are Royal Mail shares cheap?

I have written before about my suspicions that Royal Mail shares are a bargain in the current market. Let’s take a more updated look at the price-to-earnings (P/E) ratios of Royal Mail and its competitors.

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By looking at P/E ratios, I can better understand if a share price is under- or overvalued. This ratio is found by dividing the share price by earnings, or forecast earnings for forward P/E ratios. 

Royal Mail has trailing and forward P/E ratios of 3.74 and 6.11. By contrast, US competitor FedEx has ratios of 10.92 and 9.18. 

German postal service Deutsche Post has trailing and forward P/E ratios of 10.35 and 9.84. Since Royal Mail has lower P/E ratios than these two competitors, this is an indication that Royal Mail shares are potentially cheap at current levels.

Since March, the difference between Royal Mail’s ratios and those of the two competitors have stayed broadly the same.

Consistent financial results

In addition, financial results show strong growth. For the years ended March, between 2017 and 2021, profit before tax increased from £355m to £726m. What’s more, revenue rose from £9.7bn to £12.6bn. It should be noted, however, that past performance is not necessarily indicative of future performance.

In results for the three months to 31 December, the business reported that domestic parcel revenues were up 43.9% compared with the same period in 2019. 

On a year-on-year basis, however, domestic parcel revenue fell by 4.9%. This higher figure in 2020 was largely due to higher demand during the pandemic lockdowns. 

The company is also streamlining its operations, cutting 700 management-level roles at an initial cost of £70m. This could save the firm around £40m per year.

Some risks

There are risks associated with buying Royal Mail shares for my portfolio. Inflation and the cost of living may affect future profit margins. The risk of a margin squeeze caused by wage inflation is a very real possibility and could be bad news for Royal Mail shares.

There is also the threat of lower parcel volumes as we emerge from the pandemic. This prompted Credit Suisse to downgrade Royal mail shares from 558.11p to 345p. This is something I will be watching closely.  

Overall, the potential cheapness of Royal Mail shares is appealing to me. There are risks associated with the company, including the broader financial environment of higher inflation and interest rates. While the business has a strong financial record, I will wait until these risks subside before buying Royal Mail shares.

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Andrew Woods 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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