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The Royal Mail (LSE: RMG) share price is recovering. Is it a buy?

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The Royal Mail (LSE: RMG) share price is up 72% to 214p, from its March low of 124p. Indeed, it surged 17% yesterday alone as news came that parcel deliveries are booming, and its finances are looking better than expected.

This good news was reported by a positive five-month trading update, stating that parcel revenues are up 33% from last year, and total revenue increased by £139m.

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However, letter volumes declined 28% and letter revenues dropped by 21%. In addition, the combined costs of adapting the business from letters to parcels, and dealing with the Covid-19 outbreak, added £160m to its outgoings.

So, all in all, despite a bit of good news, Royal Mail is continuing its trend of declining profits. Moreover, it is expected to make a material loss this year. 

Royal Mail shares maybe overvalued 

The median 12-month price target for Royal Mail sits at 165p per share. Of 13 analysts, Goldman Sacks is the most positive, offering 200p target. However, even this is below the current trading price of 214p, indicating that Royal Mail stock could be overvalued.

Indeed, according to the Financial Conduct Authority (FCA), Royal Mail is one of the most shorted stocks. Short sellers effectively bet against a company’s shares by borrowing them, selling them, and then buying them back at a lower price before returning the shares. The seller then pockets the difference.

This entire strategy centres on high confidence that a stock will drop in price. So, the fact that institutional short-sellers are on to the Royal Mail doesn’t build confidence in the firm’s current prospects; the share price is expected to fall.   

What is the future for the company?

That said, there is recognition among management at the Royal Mail that if the business can adapt from focusing on letters to parcels quickly enough, it could be in a good position for the future.

However, this will depend to a large extent, on the willingness of its workers’ unions to facilitate the move. Currently, there is an over-reliance on sorting letters by hand and outdated working practices. Automating many of these processes to improve efficiency will likely involve job losses, or certainly personnel movements. Consequently, moves to turn the postal business around are meeting resistance.

From a business perspective, this friction prevents Royal Mail from attending to the needs of its customer base, and by extension, its shareholders. Fewer customers means less revenues, smaller profits, and perhaps no dividend re-installation.

Customers want parcel deliveries and urgent post. Indeed, next-day delivery is often essential for many businesses and other Royal Mail customers. Being able to deliver these requirements is vital to the future success of the firm.

Until Royal Mail reaches agreement with its unions, the transformation it needs cannot occur. I’m holding back my money until it does. 

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Rachael FitzGerald-Finch 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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