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Royal Mail - mixed Christmas as strike threat weighs

Nicholas Hyett, Equity Analyst | 6 February 2020 | A A A
Royal Mail - mixed Christmas as strike threat weighs

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Royal Mail PLC Ordinary GBP0.01

Sell: 267.60 | Buy: 267.90 | Change 0.30 (0.11%)
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Underlying revenues rose 4.5% in the first 9 months of the year. That was driven by growth in the international and UK parcels businesses, while the letters business continued to shrink.

Full year operating profit guidance remains unchanged for the current year, although industrial action may negatively influence 2020-21.

The shares fell 8.9% in early trading.

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Our View

When it listed on the stock market Royal Mail had two major selling points. Firstly that ecommerce would drive a rapid increase in parcels and secondly that years of public ownership meant it had plenty of room to improve efficiency. That would boost margins - helping profits grow even if revenues struggled.

Unfortunately disagreements with unions mean cost savings are proving harder to deliver than expected. In fact, averting industrial action means costs are increasing. Adding to the pain is a letters business which is struggling even more than expected - mainly thanks to a collapse in marketing mail. The combination of falling revenues and stubbornly high costs is stamping out UK profit margins.

There's better news from the international business. A few years ago we would have described this unit as small, but impressive growth, acquisitions and a struggling UK operation means it now accounts for the majority of profits. With UK profits potentially falling into negative territory, investors look set to find themselves more reliant on international mail to deliver the dividend than they might like.

Against that background it's perhaps no surprise that CEO Rico Back decided drastic action is needed. The group will be automating its UK sorting operations - with a particular focus on improving efficiency in the manual parcels sorting process. Along with existing spending plans, that will see the group invest £1.8bn in the UK postal system over 5 years.

The overseas business is also attracting attention, with investment behind organic growth as well as acquisitions. A focus on growing scale in B2B parcels underpins the division's target for revenue of EUR4.5bn by 2023/24.

Unfortunately all that extra investment comes at a price, and the first casualty was the dividend. The payment to shareholders will be 40% lower this year than last, and the commitment to grow it has been scrapped as well. Although there's theoretically room for additional returns from time to time, even the current 8% prospective yield is far from guaranteed and depends on cash coming in as planned.

A manageable level of debt is in the group's favour, but major organisational restructures are expensive and risky. If the group continues to face major opposition from its employees that will only make the transition more difficult.

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Third Quarter Trading Update

The UK parcels and letters business (UKPIL) saw underlying revenues rise 2.1% in the first three quarters. That reflects a 4.9% increase in parcels revenue (with volumes up 4%), offset by a 0.4% decline in letter revenue (volumes down 8% excluding election mailings).

Black Friday and Cyber Monday delivered higher than expected parcel volumes although the rest of the Christmas period was quieter than expected. Parcel volumes picked up in January and the premium tracked service continues to outperform the wider offer.

The international GLS division saw organic sales rise 7.3% (11.1% including recent acquisitions). The turnaround of the US business is on track, with good growth in Germany, Belgium and Eastern Europe.

Ongoing conflict with the Communication Workers Union (CWU), which is balloting its members regarding strike action, is slowing the transformation plan and resulting in customers moving parcel volumes elsewhere.

Guidance for 2019-20 has generally been maintained. However, letter volumes are now expected to be lower in 2020-21 and together with the current industrial relations environment means there is a higher chance UKPIL will be loss making next year.

Find out more about Royal Mail shares including how to invest

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.

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