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Royal Mail slashes its dividend by 40% and shares jump. Time to pile in?

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To say that FTSE 250 member Royal Mail (LSE: RMG) has failed to deliver for investors in recent times is putting it mildly.

At the close of play yesterday, the shares were priced at just over 211p a pop — almost 62% lower than where they were exactly one year ago.

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Today, however, they’re recovering strongly as investors react to the company’s proposed new strategy and its results for the full year.

Profits plummet

Revenue rose 2% to a little under £10.6bn in the 53 weeks to the end of March. Broken down, the company’s UK business reported parcel revenue growth of 7%, allowing it to offset a (now predictable) decline in total letter revenue of 6%. 

Revenue growth at General Logistics Systems (GLS), its parcel delivery network in Europe, came in at 8% with volumes up by 5%. 

In spite of this, adjusted pre-tax profit fell 30% from £565m to £398mn, even though transformation costs of £133m were less than expected. Understandably, however, the market was focused on what happens next.

New strategy

Unveiling a new strategy, CEO Rico Back stated that the company intended to “build a parcels-led, more balanced and more diversified international business”.

This, it is hoped, will allow Royal Mail to report operating profit margin of more than 4% in 2021/22 and then over 5% two years after that.  

A lot of this will depend on the success of its new ‘turnaround and grow’ plan for its UK business, which includes the introduction of 1,400 parcel postboxes following a trial in 2018.

GLS will also be scaled up with the intention of it making “a major contribution” to the company’s geographical and product diversification.

Of course, all this needs to be paid for, which will put a strain on cash flow. 

That’s why the biggest announcement of the day for investors surely relates to the rebasing of Royal Mail’s dividend.

A final payout of 17p will be paid this year, giving a total cash return of 25p per share — up 4% on the previous year. This gives a monster trailing yield of 11.3%.

The payout will then be reduced to 15p per share from 2019/20 “which may be supplemented by additional payoutsif cash flow allows.

I wouldn’t hold my breath on the latter. 

Worth buying?

Royal Mail’s shares rallied in early trading. While that may seem strange considering a whopping 40% cut to the dividend, yesterday’s 9% fall suggests that a lot of investors saw this coming.  

Personally, I’m all in favour of a struggling company reducing its dividend, albeit belatedly. Based on the share price at the time of writing, the new payout will see the shares yielding a tempting 6.8%. 

Nevertheless, I’m still wary. In 2019/20, the company is predicting a 5% to 7% fall in letter volume as a result of “continuing business uncertainty” (read Brexit) and “the ongoing impact of GDPR“.  

While growing parcel volumes might take some of the strain, Royal Mail still faces severe competition from the likes of Amazon. The latter’s share of the UK delivery market grew from 3% in 2013 to 7% in 2018.

And as the government continues to tear itself apart over the manner of our EU departure (and alienate previously loyal voters in the process), there’s also the possibility of Jeremy Corbyn becoming PM and eventually renationalising the business.

With so many better opportunities elsewhere in the market, Royal Mail just isn’t worth the risk in my opinion. 

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Paul Summers 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.