Royal Mail (LSE: RMG) is one of the most stable businesses I have ever come across and, as such, I think it could make for an excellent addition to my portfolio.
One of the reasons why I’m attracted to Royal Mail and its stability is the fact that is has manageable debt levels for what is, in my eyes, a utility company.
Of course, not all investors will consider Royal Mail to be a utility but, for me, the high degree of visibility with regard to its revenue and earnings, as well as the likelihood that parcels and letter delivery will be required for a good while yet, mean that it is most similar to a utility than many other sectors.
As a result of this stability, Royal Mail could take on a lot more debt than it currently does, in my view. For instance, the debt-to-equity ratio is currently 91%; however, electricity and gas providers carry far higher levels of debt on their balance sheet than this.
So, Royal Mail’s balance sheet appears to be only moderately leveraged and this gives me confidence as an investor in the business. Not only does it mean less risk (and therefore more stability) but it also means that Royal Mail can borrow significant amounts to invest in the business, should it wish to do so.
In addition, Royal Mail seems to offer good value at current price levels. Interestingly, one feature that was highlighted extensively by management during the IPO was the strength of the company’s cash flow. Indeed, such strength is highlighted when shares are analysed on a free cash flow yield, with Royal Mail offering a yield of 7.6% to investors.
This is impressive and not only confirms the strength of cash flow but also provides evidence that shares are currently good value.
Another feature of Royal Mail that makes me keen to buy shares in the company is the high barriers to entry that exist. Certainly, many companies would like to compete with Royal Mail but the sheer cost of doing so is highly prohibitive, as well as the six days per week service that is offered to all addresses across the UK. Even maintaining staff on all six days so as to access the UK in its entirety would be hugely costly for a new entrant.
Therefore, although it is possible to compete with Royal Mail on a local level (in other words in towns and cities) doing so on a national scale would prove to be very difficult, both logistically and financially. Therefore, margins should be maintained in future years as Royal Mail enjoys protection from relatively high entry barriers.
> Peter does not own shares in Royal Mail.