It’s been a tough 12 months for Royal Mail (LSE: RMG) shareholders. But the postal operator’s share price is now up by nearly 15% from the lows seen back in June. A trading update on Thursday confirmed expectations for the current year are unchanged. As I’ll explain, I’m starting to feel the shares could be worth buying at this level.
This is the plan
In a statement at the Royal Mail AGM last week, chief executive Rico Back confirmed the group’s performance so far this year has been in line with expectations. He also went further, saying “all targets and ambitions” mentioned in the group’s 2018/19 results remain unchanged. I’d imagine this refers to his five-year plan to spend £1.8bn turning Royal Mail into a parcel-led, international business.
Looking at the numbers, the company is targeting sales growth of about 2-3% per year between now and 2024. Profit margins are expected to fall this year but recover to 5% by 2023/24.
Letter volumes expected to continue falling by up to c.6% each year, so increasing parcel volumes will be a key element of this plan. My understanding of the numbers suggests that Royal Mail will need to take market share from rival parcel firms, if it’s to offset falling letter revenues.
Keen pricing will be essential. To help protect profit margins, Back is planning for cumulative cost savings of £1bn over the next five years.
What could go wrong?
As I discussed recently, Royal Mail’s UK-wide infrastructure and large, unionised workforce mean its cost base is larger and less flexible than most of the courier firms it competes with. Back’s challenge is to turn the group’s large-scale and dense UK footprint into a competitive advantage. I’ve always believed this should be possible, but it’s unlikely to be easy or cheap.
Royal Mail plans to spend an extra £400m-£500m over the next five years, in addition to annual capital expenditure of £400m. This big spending highlights the capital-intensive nature of this business. For example, Royal Mail has about 49,000 vehicles, all of which need replacing every few years.
In my view, there are two main areas of risk for shareholders. The first is it will prove difficult to gain employee support for changes to working practices and wider restructuring. The second is that Back’s changes may succeed operationally, but could still fail to lift profit margins to a level where shareholders can enjoy reliable returns.
Despite these risks, I do believe RMG shares offer an opportunity for long-term investors. The shares are much cheaper than they’ve been for some time and trade on 9.1 times forecast earnings, with a forecast dividend yield of 6.8%. The current market-cap of £2.2bn is also supported by the group’s property assets, which are valued at £2bn.
I think this could be a good opportunity for investors to load up with Royal Mail shares, and would rate the stock as a long-term buy.
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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.