Why is the Royal Mail share price falling?

Shares in Royal Mail have underperformed over the last 12 months. Here, Edward Sheldon looks at what’s going on.

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Royal Mail (LSE: RMG) shares have had a poor run recently. A year ago, the RMG share price was hovering around the 500p mark. Today however, it’s at 325p.

So why is the Royal Mail share price falling? And has this big decline provided a buying opportunity for me?

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Why Royal Mail shares have tanked

In my view, the big share price fall here is down to a combination of factors. The first is weaker parcel volumes.

During the pandemic, Royal Mail saw parcel volumes explode on the back of the boom in online shopping and high demand for Covid-19 test kits. However, recently, e-commerce sales have dipped as physical stores have reopened and people have stopped ordering test kits, impacting the company. In the last quarter of calendar 2021, for example, domestic parcel revenue was down 5% year-on-year.

The second is inflation. In its last update, the company said it was seeing upward pressure on costs. This is likely to hit profits in the near term.

Analysts at Citigroup forecast 5% wage inflation and 6% inflation in non-personnel costs to hit results for this financial year (ending 28 March 2023). As a result of spiralling costs, analysts are reducing their earnings forecasts for this year. Over the last three months, the consensus forecast for FY2023 earnings per share (EPS) has fallen by about 14%.

A third factor is weaker economic conditions. This could hit consumer demand in the near term. This, in turn, could translate to lower parcel volumes.

Finally, broker sentiment towards RMG shares has really deteriorated this year. In March, for example, Deutsche Bank downgraded the stock to ‘sell’ from ‘buy’, while Credit Suisse cut it to ‘underperform’ from ‘neutral’. More recently, analysts at Barclays cut their price target by a whopping 38% to 400p. This kind of broker activity will have put a lot of pressure on the share price.

Should I buy Royal Mail shares now?

So is the stock worth buying after the recent pullback? Well, it certainly looks cheap. With analysts expecting EPS of 53.6p for this financial year, the forward-looking P/E ratio is just six.

That valuation does seem low. If business conditions improve, the stock could potentially see a rerating, where the share price rises as investors are willing to pay a higher valuation for it.

Meanwhile, there could be some big dividends on the table here. For FY2023, analysts expect the group to pay out 7p per share in dividends. At the current share price, that equates to a yield of around 7%.

However, one thing that turns me off this stock is its patchy track record. In the past, its profits have fluctuated a lot. And so have its dividend payments. In recent years, it has cut its payout.

Another thing I don’t like here is the low level of profitability. In the past, Royal Mail has not generated a high return on its capital. Companies that generate low returns often turn out to be poor investments as they don’t grow much over the long run.

Weighing everything up, I think there are better stocks to buy today.

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Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. 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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