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The Royal Mail share price: why I’ve turned positive after a year

The last time I wrote something positive about the Royal Mail (LSE: RMG) share price was in April 2018. Then I highlighted the company as one of three dividend stocks I might pick for a retirement portfolio.

Unfortunately, this turned out to be a bad call on my part. The stock jumped around 13% in the three weeks after the article was published, hitting an all-time high of 631p in May 2018.

But then dark clouds started to gather over the business. By October, the stock had lost around 50% of its value, excluding dividends, and the shares have continued to slide ever since.

Growing concerns 

Since my last positive article, I’ve warned about the perils of investing in this business on multiple occasions as it quickly became apparent to me Royal Mail would have to take drastic action to reorganise its business.

Indeed, in October 2018, I flagged a forecast from analysts at Wall Street bank JP Morgan which declared Royal Mail could have to borrow money to fund its dividend as earnings from operations collapsed, a concerning forecast I warned could be a precursor to a dividend cut.

The company cut its dividend at the end of May, setting a basic payout of 15p per share, down from 25p in 2018. Management has decided to go down this route as Royal Mail spends £1.8bn over the next five years to try and re-invent itself for the 21st century, investing more money in its parcels division and improving operational efficiency.

A vital part of this plan is to improve productivity by 15-18% during the next five years by increasing automation across the business.

We’ve been here before

At this point, I’m sceptical that management can pull off this transformation plan. After all, we’ve been here before. Ever since its IPO in 2013, Royal Mail has undertaken a series of restructuring and productivity improvement initiatives, but all of these efforts haven’t yielded tangible results. Even though revenues have increased by around £1bn since 2013, net profit has declined by £90m.

Still, after the recent declines, it looks to me as if all the bad news is already factored into the Royal Mail share price. City analysts are expecting the company to report a 49% decline in earnings for its 2020 financial year. Based on this outlook, the stock is currently dealing at a forward P/E of just 8.2.

This multiple is one of the lowest valuations placed on the stock since its IPO, and it’s significantly below the valuation of more than 20 times earnings investors were willing to pay in the first quarter of 2018. Also, shares in the postal service are trading at around 60% of tangible book value.

The bottom line

I’m not saying the Royal Mail share price won’t fall further from current levels. But these metrics suggest to me the stock is undervalued right now. But if the company’s performance does start to improve, I reckon there’s a good chance the shares could trade back up to book value. 

So, while Royal Mail might not be out of the woods just yet, it might be an attractive investment for bargain hunters with a high-risk tolerance at the current price.

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Rupert Hargreaves owns no share 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.