Never mind the quality, just look at that income. The collapse in the Royal Mail Group (LSE: RMG) share price has driven the yield to an eye-watering 15%, but don’t be fooled by that headline number, because it’s about to fall sharply.
As Royal Mail’s problems mount, management is cutting the dividend from 25p to 14.33p in the year to 31 March. That’s yet another blow for loyal investors, although it is still forecast to yield a handsome 8.1% this year. Should you be tempted by this troubled enterprise?
The controversy surrounding Royal Mail’s privatisation in October 2013 seems an awful long time ago now. The complaint then was that the Government had massively undervalued the stock (and shortchanged the taxpayer), as the share price shot past its 330p initial pricing, to top 600p. Now it looks massively overvalued, trading at just 167p today.
Right Royal disaster
This makes Royal Mail a terrific example of why you should heed the first part of billionaire investor Warren Buffett’s famous maxim, “be fearful when people are greedy,” and shun any stock where investors are getting over-excited or looking to make a quick buck.
So should you now follow the second part of the saying, and be “greedy when people are fearful”? Investors are certainly fearful of Royal Mail right now. Its share price has fallen a whopping 40% in the last 12 months, and trades 70% down on two years ago.
There is some good news out there. This month’s trading update showed the company on course for group operating profit of between £300m and £340m for 2019/20 (before the impact of IFRS 16 accounting changes).
However, the share price still plunged as management warned of “challenging” times ahead, with letter volumes set to fall faster than expected, while its UK parcels and letters business is heading for a loss, amid the uncertain business environment.
The Communication Workers Union (CWU) is now threatening the first national postal strike in a decade. This would be bad news for Royal Mail, and good news for rival companies in the crowded courier market as those rivals will pick up any dissatisfied customers. Competition from Amazon Logistics will also strike fear into many.
Even more worryingly, Royal Mail’s net debt has soared from £470m to £1.37bn, while broker Liberum has added to the misery by warning that its transformation strategy may be undeliverable, as margins are squeezed by poor productivity and declining revenues from letters.
Brave contrarians may be tempted by today’s valuation of just 5.5 times earnings. However, that is expected to jump to 17.4 times this year, due to a forecast 31% drop in earnings this year, followed by another 46% fall next.
The earnings outlook for 2022 is brighter, but I’ve heard enough. Management faces a long-term battle, and there are dozens of stocks I’d buy ahead of Royal Mail right now.
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Harvey Jones 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.