Are Royal Mail shares the best bargain buy in the FTSE 100?

Jon Smith considers whether the fall in Royal Mail shares over the past year warrant buying now as an undervalued option.

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Over the past year, Royal Mail (LSE:RMG) shares have fallen by 52%. This is quite a large fall, especially when you consider the profitability of the company over this period. It has endured problems in the process, but I personally think that the stock is now becoming an undervalued bargain buy.

Some valid reasons for falling

Before I get to the reasons why I believe Royal Mail shares are great value right now, I want to run through the fall.

One reason for this has been reputational damage around the failure to meet delivery targets. Last month, Ofgem announced that there would be an investigation into failings. Royal Mail blame the operational issues on a shortage of workers earlier this year due to self-isolation requirements. With the Covid-19 mandated isolation period, the company was faced with a workload that was difficult to manage.

Another problem that the business has faced is high competition and slim operating profit margins. Although GLS managed to to grow revenue by 4.4% last year, Royal Mail saw a fall of 1.6% versus the 2020/21 figures. It also has an operating profit margin of just 6%. This makes it very vulnerable to flipping from a profit to a loss if costs increase or revenue dips.

Why I think Royal Mail shares are undervalued

From a valuation perspective, the share price looks undervalued. The price-to-earnings (P/E) ratio is a metric that I use to see if a stock is a bargain or not. Ideally I want the ratio to be in single figures, but not a ratio of one or two. If it’s that low then it’s clear to me that investors are staying away for good reasons!

At the moment, the Royal Mail P/E ratio is 4.70. This sits in the perfect spot where I think it represents a bargain. I also think the part that is low is the price. Earnings for 2021/22 were solid, with a profit before tax of £662m. Therefore, I think the share price has room to move higher in order to bring the P/E ratio up to a fairer level.

Another point that impresses me is the push towards automation. In the latest annual report, the CEO commented that “over 50% of parcels are now processed automatically, the delivery of two new parcel hubs are on track, and we are reinventing our services and digital experiences.”

Automation will be able to lower long-term costs for the business. It’ll also help to provide higher efficiency, allowing the firm to scale up in a more sustainable manner. Finally, it should help Royal Mail to compete better with rivals than are already heavily tech focused.

The best value in the FTSE 100?

I think Royal Mail shares are a bargain buy right now. I want to buy the shares as soon as I have some free money. However, saying it’s the best value stock in the FTSE 100 is very subjective. From my point of view, it’s definitely in the top 10 options right now. Before I could give it the crown of being number one, I’d want to research the other viable candidates!

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.

Jon Smith and The Motley Fool UK have 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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