Royal Mail’s (LSE: RMG) share price has bounced recently. This week, it’s up more than 25%. Here, I’ll look at why its shares have risen this week. I’ll also explain how I’d play RMG now.
Higher revenues
The reason RMG shares have bounced is that the market liked the company’s AGM trading update, issued on Tuesday. There were a number of positives to take away from this update.
For example, the company said for the five months to 30 August, Royal Mail (UK) revenue was £139m higher than the same period last year. Meanwhile, it advised annual revenue is likely to be £75m-£150m higher year-on-year for the fiscal year 2020-21 if another lockdown isn’t implemented. Back in June, the company advised that full-year revenue could be £200m-£250m lower.
Furthermore, Royal Mail said parcel volumes had surged 34% year-on-year. It believes there’s an opportunity to benefit from the rapidly growing demand by customers for parcels, if it can adapt its business quickly enough.
However, the update wasn’t all positive. On the downside, Royal Mail advised that letter volumes fell 28% over the period, resulting in a 21.5% dip in letter revenue for the period.
It also said costs have risen significantly. The mix shift from handling more parcels and fewer letters increased costs in the period by £85m. Meanwhile, Covid-19-related costs were £75m for the period.
Additionally, it said the recent bump in parcel revenues hadn’t halted the long-term decline in its profitability. “We continue to expect Royal Mail to make a material loss this financial year 2020-21 and will not become profitable without substantial business change,” the company said.
Royal Mail shares: my view now
Parts of Royal Mail’s AGM trading update were certainly encouraging. The outlook for the company now appears to be slightly improved.
I continue to believe, however, Royal Mail faces challenges. It’s going to have to adapt its business to focus more on parcels and less on letters very quickly. As it says, it currently has a delivery structure “that no longer meets customer needs.” Whether it’ll be able to execute this transformation remains to be seen.
Aside from the restructuring challenges the company faces, there are some other issues that concern me here. One is that hedge funds continue to short the stock. Short interest has declined this week, however it’s still relatively high. A number of hedge funds expect Royal Mail’s share price to fall.
Royal Mail also screens up as a low-quality company. Return on capital employed – a key profitability metric that top investors such as Warren Buffett and Terry Smith pay a lot of attention to – has averaged just 3.1% over the last three years. By contrast, FTSE 100 champion Unilever has averaged about 24.6% over the same period. This suggests Royal Mail shares are unlikely to deliver strong returns over the long term.
All things considered, I’d avoid Royal Mail shares for now. If I owned the stock, I’d be looking to sell on share price strength.
