So far in 2022, Royal Mail (LSE: RMG) shares have fallen 48%. Over a 12-month period, the story is even worse, with the shares falling over 54%. As a consequence, the stock is set to lose its FTSE 100 spot, being pushed into the FTSE 250 index instead. With all this negative news, is now a good time for me to buy the stock? Or should I steer clear of the UK’s largest postal service? Let’s take a closer look.
Why the shares have fallen
A key driver behind the recent poor performance is the subpar results that the firm has delivered in recent months. During the pandemic, Royal Mail shares soared, as online shopping became the norm. However, as the nation has returned to normality, the postal service has seen a decline in activity. It also experienced a severe shortage of staff earlier in the year due to the self-isolation of workers. As a consequence, it missed analyst profit targets, which investors have reacted negatively to.
Inflation has also been weighing down on stock valuations and decreasing investor sentiment. The subsequent cost-of-living crisis could lead to a drastic shortfall in demand. Royal Mail has an operating profit margin of just 6%, so any slight fall in demand could leave it susceptible to losses. In addition to this, the postal courier space is hot with competition, with firms like UPS and DPD threatening the group’s market share.
Another risk that worries me is the threat of union action on wages. The Communication Workers Union (CWU) is demanding wage rises to compensate for the increased cost of living. Royal Mail currently has around 400k employees, and even a small increase in its wage packages could lead to hundreds of millions in added expenditure. With margins already feeling the pressure, this is the last thing the firm needs. If an agreement is not reached, it could lead to strike action, which would undoubtedly force Royal Mail shares lower.
Undervalued opportunity
Although there are risks, the current share price does look tempting, especially considering its low valuation. The shares currently trade on a price-to-earnings (P/E) ratio of just 4.4. For comparison, competitors DPD and UPS trade on P/E ratios of 8.1 and 14 respectively. This shows me that the shares are undervalued compared to the wider market. In addition to this, Royal Mail currently pays a healthy 6.1% dividend. This could help my portfolio offset the effects of rising inflation while topping it up with passive income.
The verdict
There is no doubt that the shares look cheap, and the healthy dividend does appeal to me. However, I think there are too many risks outweighing the investment case for this stock. The rising cost of living is muting consumer demand, and the threat of union action could place big pressure on already thin margins. For this reason, I won’t be buying Royal Mail shares for my portfolio today.
