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Is the Royal Mail share price heading back to 600p?

Just two months ago, Royal Mail (LSE: RMG) shares hit at an all-time high of 632p. Since then they’ve lost 26% of their value.

What’s gone wrong? One potential concern is that the new EU GDPR data protection regulations are expected to cut junk mail volumes, accelerating the decline of the group’s letters business. This may well be true, but it’s only extending a trend that has been in place for several years.

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Royal Mail’s management already knows its got to adapt to a parcel-led future. And new chief executive Rico Back is an expert in this area, having previously headed up the group’s GLS European parcels business.

I think we need to ask if this 500-year-old FTSE 250 business can possibly be worth 26% less than it was two months’ ago. I’m not convinced. In my view, this postal sell-off has probably gone too far.

Too cheap to ignore?

At £4.9bn, Royal Mail’s valuation now looks very tempting to me. The group had around £2bn of property, plant and equipment on its balance sheet at the end of March, and almost no debt.

Alongside this, it generated underlying free cash flow of £562m. This put the stock on a trailing price/free cash flow ratio of 9, which looks very cheap to me.

Looking ahead, adjusted earnings are expected to fall by about 14% to 39p per share this year, as cost pressures and falling letter volumes squeeze margins. Although this is disappointing, profits are expected to return to growth in 2019/20.

In the meantime, the forecast dividend of 25p per share should be covered 1.6 times by earnings. This looks affordable to me, given the group’s minimal debts and strong cash generation.

Indeed, with the shares trading on 12 times forecast earnings and offering a prospective yield of 5.4%, I think there’s a good chance of gains when sentiment improves towards this sector. I’d rate the shares as a long-term income buy at current levels.

A 30-year dividend record

Royal Mail isn’t the only FTSE 250 dividend stock I rate highly. Merchant bank Close Brothers Group (LSE: CBG) is another long-lived stock I’d be happy to hold in a long-term income portfolio. This City stalwart hasn’t cut its dividend for 30 years, despite the 2008/9 financial crisis.

The firm said on Wednesday that its results for the year to 31 July are expected to be in line with expectations. During the year to date, the group’s loan book has grown by 6.6% to £7.3bn, while bad debts have remained low.

The majority of the group’s lending falls into two categories — car loans for private buyers and asset finance for businesses. One risk is that this business could suffer badly in a recession. Demand for new lending would be likely to fall, and bad debt levels would probably rise.

Still a buy at record highs?

The good news is that there’s no evidence of lending problems or a recession at the moment. To help protect profits, management has slowed new lending over the last year to maintain the quality of the loan book.

A 30-year unbroken record of dividends suggests to me that this firm’s management knows how to manage risk.

With the shares trading on a 2018 forecast P/E of 11 and offering a 4.2% yield, I’d rate this bank as a long-term buy-and-hold stock.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has 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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