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Royal Mail - moving from UK letters to international parcels

Nicholas Hyett, Equity Analyst | 25 June 2020 | A A A
Royal Mail - moving from UK letters to international parcels

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Royal Mail PLC Ordinary GBP0.01

Sell: 482.80 | Buy: 483.20 | Change 0.00 (0.00%)
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Royal Mail's full year revenue rose 3.8% to £10.8bn, driven by continued growth in the international GLS business. However, increased costs in the UK relating to the threat of industrial action and the coronavirus outbreak meant underlying operating profits were 13.6% lower at £325m.

Alongside results the group announced an extensive restructuring plan - aimed at cutting costs while investing in parcels infrastructure in the UK and abroad. The group will not pay a final dividend and does not intend to a pay dividend in 2020/21.

The coronavirus outbreak mostly affected the period after the year end, with letter volumes down by a third and parcel volumes up by 37%.

The shares fell 8.6% in early trading.

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Our View

Royal Mail is in a better position than some - its core letters and parcels business continued to trade through the lockdown. However it's far from unscathed.

Letter volumes have collapsed in the first two months of the new financial year, led by a 63% fall in advertising mail. Parcel volumes have surged as consumers move to online shopping, but extra costs associated with servicing the demand make that as much a burden as a blessing. Combine all that with a potentially painful recession and we expect significant losses next year.

While a pandemic might have been unpredictable, the current crisis is only highlighting some long suspected weaknesses. The group's been over reliant on the shrinking letters market and underinvested in parcels infrastructure. Those problems go back years and haven't been helped by a highly unionised workforce which has, at times, made it difficult to introduce change.

The contrast between the smaller international GLS business and the core Royal Mail operation is stark. Not only are GLS revenues rising, and expected to rise again next year, but an operating margin of 6.2% is four times what's being achieved in the UK.

Getting the UK business up to scratch will be top of the agenda for the new CEO when he/she is appointed. In the meantime recently appointed Chairman, now executive Chairman, Keith Williams has set out his short term priorities.

The former British Airways executive has experience dealing with a heavily unionised workforce, and plans to cut 2,000 roles suggest he is prepared to make unpopular decisions. Other operating costs are also under microscope - although the deadline on efficiency and profitability targets has been pushed back from 2024 to a yet to be determined later date.

Cost discipline should pay dividends long term but it must be accompanied by considerable investment in technology.

Royal Mail is looking to automate its UK sorting operations - with a particular focus on improving efficiency in parcels. Along with existing spending plans, that was expected to see the group invest £1.8bn in the UK postal system over 5 years. Those investments might be delayed or trimmed now, but it's still a sizeable commitment.

The combination of short term uncertainty and long term investment demands have led the group to cut its dividend this year and next. That will be unpopular with shareholders but we think it's the right decision. Royal Mail's balance sheet may be in relatively good shape now, but with several years heavy investment to come it won't stay that way.

It's hard to overstate the challenges that face Royal Mail at the moment. Trimming costs, investing in technology and adding to international acquisitions are, in our opinion, the right answers. However, coming up with answers and executing them are very different things, and Royal Mail's track record doesn't inspire confidence.

Royal Mail key facts

  • Since Royal Mail is expected to be loss-making next year it is not possible to give a PE ratio
  • Prospective yield - 0%

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Full Year Results

Royal Mail's UK business, UKPIL, saw revenues rise 1.6% in the year, reaching £7.7bn. That reflects a 2% rise in parcel volumes and 4.6% rise in parcel revenues, offset by a 0.9% decline in letter revenues as letter volumes fell 8%. The group benefited from targeted price increases during the year. However a 2.8% increase in adjusted operating costs meant UKPIL operating profits fell 41.2% to £117m.

GLS volumes rose 4%, excluding acquisitions, with revenue up 6.3%. Operating profits rose 13.5% to £208m.

Royal Mail is looking to reduce the number of management roles in the organisation by around 2,000 this financial year - with half of the company's senior leaders and most senior managers expected to leave in the next few months. The restructure is expected to cost £150m and deliver annual savings of £130m. The group expects non-people costs to be flat next year, as increased parcel volumes are offset by cost savings elsewhere. UK Capital expenditure will fall by £250m.

Net debt rose from £300m at the start of the year to £1.1bn at year end. This largely reflects the change in accounting treatment of leases, without which net debt would actually have fallen. Operating free cash flow in the year came in at £556m.

The outlook remains uncertain. However Royal Mail has modelled two possible scenarios from the coronavirus outbreak, forecasting a revenue fall of £200m-£250m or £500-£600m in the UK and 5-7% or 0-2% growth in GLS. Costs rise under both scenarios with the result that the UK becomes substantially loss making.

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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.