How Safe Is Your Money In Royal Mail PLC?

Royal Mail (LSE: RMG) shares surged to more than 600p early this year, but the post-IPO froth is now coming off the stock, which has fallen by 14% so far this year, to 490p.

One reason for this is Royal Mail’s disappointing post-Christmas sales update, which revealed that the privatised postal service failed to capture any of the growth in the key parcel market over the busiest trading period of the year.

royal mailAs a potential investor, my concern is whether Royal Mail’s underlying finances are sound: will next year’s forecast 20p+ dividend be safe if growth remains elusive?

1. Interest cover

What we’re looking for here is a ratio of more than 2, to show that Royal Mail’s earnings cover its interest payments with room to spare:

Operating profit / net finance costs

£353m / £23m = 15 times cover

I’ve excluded the £1.35bn non-cash ‘profit’ that resulted from the changes to Royal Mail’s pension scheme last year, and focused on the underlying operating profit before transformation costs.

Interest cover of 15 times suggests that Royal Mail’s current profits give it plenty of headroom to cope with debt repayments, so no major concerns here.

2. Gearing

Gearing is simply the ratio of debt to shareholder equity, or book value. I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.

In its most recent published accounts, Royal Mail reported net debt of £743m and equity of £2,394m, giving net gearing of 31%. This is comfortably lower and shouldn’t cause any problems for shareholders, especially as the firm’s net debt has fallen by an average of 19% per year since 2011.

3. Operating margin

Excluding the effect of the pension scheme changes, Royal Mail’s operating margin was 7.8% during the first half of this year.

Although this is a respectable figure, it hides a worrying trend, in my view. Royal Mail’s revenue and profits only rose during the first half of this year because it was able to hike its parcel rates.

The firm’s letter volumes fell, as expected, but parcel volumes were flat, which is worrying, as the wider parcel market is growing fast; if Royal Mail cannot maintain its share of this key market, then the firm’s profits could come under serious pressure over the next few years.

Is Royal Mail a safe buy?

Royal Mail’s dividend is likely to remain safe, but I believe there are far better alternatives available for investors looking to add new money to their portfolios.

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Roland does not own shares in Royal Mail.