Am I missing something about Royal Mail shares?

Jon Smith scratches his head at the continued fall in Royal Mail shares and tries to find out what’s going on.

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Sometimes as an investor, I have a view that disagrees with the broader market. In that case, I always try and double-check my thinking, in case I’ve missed something obvious. With Royal Mail (LSE:RMG), I feel I need to do this. Royal Mail shares are down 53% over the past year. But with a low price-to-earnings ratio, I think it’s time to buy. So what’s going on?

Understanding the bearish view

I can understand the fall in the share price from late last year and also during Q1 of this year. The company was hampered by staff shortages due to self-isolation requirements with Covid-19. This had a knock-on impact of causing delivery delays. Even though the business is pushing for more automation, it still relies heavily on manual processes. So a lack of staff had a negative impact on the postal service.

At a broader level, I also get the view that the pandemic boom for Royal Mail is coming to a close. It was a unique period when we were all stuck at home, ordering almost everything online, which then needed to be posted to us. The parcel side of Royal Mail and GLS surged during this period.

This situation has now changed and is unlikely to come back again (even the thought of another lockdown makes me shudder). So it’s understandable that the share price has fallen from the highs as a recalibration happens to the new normal.

Still convinced about value

Even though I’m not surprised the share price has fallen, I’m surprised by the extent of the fall. 53% in a year makes me think that the stock has been oversold.

For example, the adjusted operating profit for last financial year was £758m. The year before that it was £702m. The outlook for the 2022/23 financial year is currently at £638m. Granted, this is a around a 15% fall from last year, but it’s by no means a disaster. It’s also significantly higher than the pre-pandemic years of 2018 and 2019.

The move in the share price relative to earnings leads me to turn to the price-to-earnings ratio, where I expect a low figure to back up my hunch about the stock being undervalued. I’m correct, with the ratio at just 4.47.

When I look at the comments from management, I note challenges but also opportunities. The CEO spoke of how “over 50% of parcels are now processed automatically”, with “the delivery of two new parcel hubs on track”. So again, I ask myself why the share price is so deflated and in a continued downward spiral. A future with a more streamlined and automated business that leads to lower costs and higher profits will only be a good thing overall.

It might be the case that I am missing something fundamental in my analysis, but I don’t think I am. The role of the unions, inflationary pressures, and other points are noted, but I don’t see them as a deal breaker for me buying the stock. Therefore, it’s on my list of stocks to buy when I get some more free cash.

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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