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Royal Mail - Results beat expectations

Nicholas Hyett | 16 November 2017 | A A A
Royal Mail - Results beat expectations

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Royal Mail PLC Ordinary GBP0.01

Sell: 482.80 | Buy: 483.20 | Change -5.20 (-1.06%)
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Royal Mail reported a 2% rise in group revenues of £4.8bn in the first half. Underlying operating profits rose 7% to £323m before transformation costs.

The shares rose 1.7% in early trading, as results came in slightly ahead of market expectations.

The interim dividend of 7.7p per share rose 4% compared to last year, in line with the groups policy of paying a third of the prior year's total dividend.

Our View

The steady decline in letters we send and receive is far from ideal for Royal Mail. But with the growing UK and International parcels businesses now delivering almost 60% of total revenues, it should become less of a headwind.

Online shopping provides a steady tailwind to the parcels operations, and that has the potential to transform Royal Mail from staid former-public sector giant into a surprisingly modern growth story.

Royal Mail isn't the only player trying to get a slice of the online retail pie though. Deutsche Post, the big boy of European post, has stepped into the market through the acquisition of struggling UK Mail. That adds to pricing pressure in an already crowded sector.

Another problem is that new age competitors are far slicker operations than Royal Mail. The contrast between Amazon's robotic warehouses and Royal Mail's sorting offices is stark. If the group is to win in a highly competitive sector it needs to modernise, and at some pace.

The group has warned that the "industrial relations environment" could hamper the speed of change. The current pensions dispute will be a test case for whether Royal Mail and its workforce can find a harmonious way forward.

However, we feel Royal Mail has some unique advantages over rival postal operators.

It's by far the largest UK player, with over 50% of the parcel market, so can invest more in technology and service. The group is also proving unexpectedly successful internationally, and is expanding its footprint with acquisitions in Europe and the US. Profits are being supported by stripping out costs that developed over years of public ownership.

Assuming the pension situation resolves itself satisfactorily, the balance sheet is not overstretched, and the group trades on a comparatively modest 9.9 times next year's earnings with a yield of 6.2%.

First Half Results

Revenue growth was driven by GLS, Royal Mail's international parcels business, which saw 9% growth in the half and now accounts for 25% of group revenue. Revenues at UKPIL, which handles UK parcels and letters, were flat on the previous year.

Within UKPIL, letters volumes fell 5%, with revenues down 4%. This is an improvement on the first quarter and reflects improving trends in marketing mail, where the decline has moderated following the steep drop seen in the aftermath of the EU referendum.

UK parcels put in a strong performance as revenue rose 5%, on a 6% increase in volume. Continued competitive pressures means pricing pressure remains high. However, the group is seeing increased take up of its premium tracked parcel offer by business customers.

Underlying operating costs at UKPIL were 1% lower than a year ago, with the group on course to deliver £190m of costs avoided this year. However Management expect cost pressures to increase in the second half, with "the industrial relations environment" potentially impacting the pace of change.

There's no update on the ongoing pensions arbitration talks, which are expected to last until "close to Christmas".

The group is now targeting full year investments of around £450m, compared to £492m last year.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.