Royal Mail has released results covering the nine months ended 27 December 2015. The group has navigated the peak Christmas period well, with 130m parcels handled in December alone, 6% more than last year.
Overall trends in UK parcels were the same as those seen in the first half, reflecting on-going competitive pressures. Performance in letters improved slightly over H1, while European parcel volumes were ahead of expectations meaning operating margins in this division are no longer expected to decline. All other guidance remains unchanged, with cost-saving initiatives said to be on track. The shares rose by 2% in early morning trading.
Key highlights for the nine month period:
- UK Parcel volumes were up 4%. Revenue grew by only 1%, due to changing mix and continued pricing pressure from the highly competitive environment.
- Addressed letter volumes declined by 3% (excluding election mailings), slightly better than the 4% decline seen in H1. Total letter revenue was down 2%.
- European parcels (GLS) performed better than expected with volumes and revenues increasing by 11% and 10%, respectively.
Royal Mail has delivered a solid performance over the key Christmas period. Double-digit revenue growth in European parcels was a highlight, while the decline in UK letters was smaller than expected. The group coped well with higher UK parcel volumes in December, but competitive pressures here show no sign of easing.
UK parcels was supposed to be the growth engine for Royal Mail, with the UK letters business in decline. So it is somewhat concerning that conditions in the UK parcel market look set to remain challenging. The demise of rival City Link in December 2014 has been followed by a host of announcements from other parcel operators warning of pricing pressures. Amazon choosing to launch its own delivery network compounds the issue. Overall, Royal Mail estimates that there is around 20% annual spare capacity in the market.
Royal Mail is in a much better position than other postal operators to weather the storm, we feel. It is by far the largest player, with around 50% of the UK parcel market, so can invest more in technology and service. There is plenty of scope to reduce costs, having spent so long in public hands. This should help to support profits, at a time when rivals are seeing margins squeezed.
We think Royal Mail is performing well in a tough environment. The UK parcels business isn't growing much, but nor is it in decline. The European parcels business (almost a sixth of revenues) is performing better than expected and costs are being very tightly managed. The group generates prodigious cash flows. The balance sheet is strong and underpinned by a substantial London property portfolio. Growth will probably be hard to come by until market conditions improve. In the meantime there is a yield of 5.1% to tide investors over.
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