Should I Invest In Royal Mail Plc?

To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value

If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing investment opportunities and today I’m looking at Royal Mail (LSE: RMG), the postal and delivery service provider.

With the shares at 492p, Royal Mail’s market cap. is £4,920 million.

This table summarises the firm’s recent financial record:

Year to March 2012 2013
Revenue (£m) 8,764 9,279
Net cash from operations (£m) 301 761
Profit before tax (£m) 201 324
Dividend per share n/a n/a

By now, most will be aware that, since the recent flotation, Royal mail’s shares have shot upwards. However, they still look reasonably attractive on a rough valuation basis.

For example, the firm estimated that it is likely to  pay an inaugural dividend costing around £200m so, at today’s 492p share price, I reckon the forward dividend yield is potentially running at around 4% and likely to be covered somewhere just above twice by underlying earnings. Meanwhile the trailing P/E rating is running at about11, and the firm enjoys an asset-backed balance sheet that seems to be worth somewhere between £1 and £2 per share, depending on property values.

But let’s not forget that Royal Mail is a business as well as a share. Is it the type of business you want to own? On the plus side, I’d point to the growing trend of internet shopping generating plenty of parcels for the firm to deliver. On the negative side I’d finger the labour-intensive nature of operations and all the associated staff costs and difficulties inherent in that kind of business, such as the recent, well-reported  industrial relations challenges the company is experiencing. As a given, I’d wave a hand at the ‘inevitable’ further decline of letter post thanks to disruptive e-communications.

I’m waiting for the half-year report, which is due at the end of November, to see how trading is going in order to put more weight on these valuation assumptions. However, my main guidance is likely to be yield, and on that basis, Royal Mail is not likely to be paying enough right now to attract me, given the risks of holding the shares.

Royal Mail’s total-return potential

Let’s examine five indicators to help judge the quality of the company’s total-return potential:

1. Dividend cover: forward earnings likely to cover the first dividend around twice. 4/5

2. Borrowings: net debt is just above the level of underlying operating profit.    4/5    

3. Growth: rising revenue has generated robust cash flow and growing earnings.  5/5

4. Price to earnings: a trailing11or so compares well with growth and yield expectations.4/5

5. Outlook:good recent tradingand, given recent flotation, an optimistic outlook. 4/5

Overall, I score Royal Mail 21 out of 25, which encourages me to believe the firm has potential to out-pace the wider market’s total return, going forward.

Foolish summary

Admittedly, I’ve made some assumptions and estimates, but Royal Mail scores well on all my business-quality and value indicators, even at the current share price. However, I’m not keen on the firm’s labour-intensive business model or the highly competitive sector in which it operates.  

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> Kevin does not own shares in Royal Mail.