The Government’s Call To Sell In Royal Bank Of Scotland Group plc And Royal Mail plc Shares Seems Wise

The UK government has already sold half of what was a 30% slice of Royal Mail (LSE: RMG). On top of that, Britain’s Chancellor of the Exchequer, George Osborne, announced a decision to flog off the country’s holding in Royal Bank of Scotland (LSE: RBS).

I’d sell these firms, too

Perhaps the government’s sell-decision on Royal Mail was easier than that for Royal Bank of Scotland. Two years ago several public voices heaped criticism on the coalition government’s decision to sell off the bulk of the postal service provider at 330p per share, after they rose immediately afterwards by around 87% on the stock market. The recent sale pulled in 500p per share, which gives commentators far less to complain about.

The decision for Royal Bank of Scotland is a bit trickier because today’s share price near 362p shows the government a loss on its average buying price around 500p. However, there’s more to share ownership than unrealised upside. Other likely outcomes of share ownership include stalemate and loss. Holding shares in any company involves risk, and in the cases of Royal Mail and Royal Bank of Scotland now I’d argue that there is no clear line of sight for these firms to deliver shareholder gains in the long run, and glaring potential to disappoint. I’d be a seller, too, and here’s why…

Competitive industry

Royal Mail’s full-year results in May showed adjusted revenue up just 1%. The firm’s outlook statement has it that the parcels and letters markets in the UK remain highly competitive.

Delivering post for a living is tough. Since the bulk of the firm was privatised two years ago, Royal Mail has done a good job of lowering its debt and curbing its costs, but that battle will remain ongoing and the business will remain difficult. I’m not expecting Royal Mail’s commodity-style undifferentiated business to shoot the lights out on growth of any kind, ever. We can see how it’s going by looking at that 1% revenue growth figure.

Although the firm enjoys competitive advantage with the breadth of its network, that’s not enough to make the company a growth proposition, and it’s not enough to guarantee profits with so many other outfits fighting for market share. If there’s little potential for growth, and post- privatisation efficiency gains largely already in the bag, Royal Mail perhaps has greater potential to surprise on the ‘down’ side rather than on the ‘up’ side. As such, the firm is not a good candidate for a long-term investment, in my view, so the government’s move to free funds tied up in the company looks like a good one.

A double drag

Royal Bank of Scotland is up against a double drag on share-price progress, which could be why the shares are flat lining, and have been since early 2013 — some two-and-a-half years.

Regulatory drag and cyclical drag are two anchors keeping Royal Bank of Scotland down. It makes little sense for the government to hold shares in a bank that it wants to squeeze into shape with regulation — there’s a conflict of interests in such a set-up.  A goal of undermining the dominance of Britain’s five biggest banks, if exercised, will work against an investment in Royal Bank of Scotland. Regulation is a powerful force working against share-price progress and I wouldn’t want to underestimate the potential for the government, unfettered by direct financial interest, to crank up the pressure on Britain’s banks.

The other big challenge for Royal Bank of Scotland is that the fortunes of the banking sector tend to mirror general macro-economic cycles. Banks are among the most cyclical of businesses and that’s what makes them poor long-term investments. Share prices in the sector rise and fall with profits and cash flow, along with the undulations of the macro-economic cycle.

Consequently, the stock market tends to marks down the value of banks as we progress through the economic cycle. We often see gradual P/E compression and rising dividend yields in anticipation of the next peak-earnings event. Cyclicality is a second powerful force working against share-price progress mid-cycle, as now. Furthermore, the longer we hold bank shares, the closer we get to the next cyclical down-dip, which often sees profit and share-price collapse. George Osborne is best out of it — why take the risk of holding on?

A wise call

The UK Government’s call to sell shares in Royal Bank of Scotland and Royal Mail seems wise although there’s still some distance to travel. George Osborne reckons it will take some years to exit Royal Bank of Scotland completely.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.