Is the Royal Mail share price a buying opportunity?

With a 6% dividend yield and a price-to-earnings ratio of 3, is the Royal Mail share price in buying territory? Or is there more going on below the surface?

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Shares in Royal Mail (LSE:RMG) have declined by around 37% since the beginning of the year. As a result, the stock now trades at a price-to-earnings (P/E) ratio of just 3.78.

The FTSE 100 currently trades at a P/E ratio of around 12.5. By comparison, shares in Royal Mail look extremely cheap.

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The falling stock price has resulted in the dividend yield increasing. At current levels, the Royal Mail dividend represents a 6% annual yield.

So are Royal Mail shares worth looking at? Or is the falling share price a sign that investors like me should stay out of the way?

Revenue and profit

Sometimes, a falling share price can be a sign that the company is struggling to increase its revenues. When a company is unable to bring in more money, the share price can respond accordingly. 

A good example of this is Unilever. Unilever’s revenues have declined slightly over the last five years. As a result, the company’s share price has fallen by around 11% during that time.

This isn’t the case with Royal Mail, though. Over the last five years, Royal Mail has increased its revenues by around 40%.

Earnings per share (EPS) have also increased. From earning 27p in EPS in 2017, the company announced earnings per share of 87p at its most recent report.

So Royal Mail seems to stack up well in terms of revenue and profit. Both seem to me to be growing at a more than acceptable rate.

Financial health

I think that what’s been holding the Royal Mail share price back is the amount of debt the business has. The company has been increasing its debt significantly over the past few years and I think this is weighing on the share price.

In 2017, Royal Mail had £430m in long-term debt and £37m in short-term debt (including lease obligations). Today, the company’s long-term debt has increased to £895m and short-term debt stands at £197m.

The consequence of that increased debt is higher interest payments. The amount that Royal Mail pays out in interest has increased by 207% since 2017. 

Overall, though, I think that the company’s interest payments should be manageable given the amount the business generates in operating income. Royal Mail’s interest payments reached $40m last year. With operating income at £929m, I don’t anticipate a significant problem there.

I also believe that Royal Mail’s substantial cash pile goes some way towards offsetting its increased debt. While total debt has reached around £2bn, the company also has just over £1.5bn in cash available. To me, that doesn’t seem like a significant cause for alarm.

Conclusion

The Royal Mail share price seems to me to be worth looking at closely. The company has been increasing its debt, but I think that remains at manageable levels and its revenue and profit have been growing impressively over the past few years.

At today’s prices, the company has an enterprise value of around £3.79bn. Against that, a free cash flow of £888m offers a 23% return from an investment perspective. I think that’s attractive and that the Royal Mail share price is worth me looking at closely.

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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Unilever. 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.

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 considered, so you should consider taking independent financial advice.

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