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Royal Mail - more losses despite revenue growth

Nicholas Hyett, Equity Analyst | 19 November 2020 | A A A
Royal Mail - more losses despite revenue growth

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Royal Mail PLC Ordinary GBP0.01

Sell: 306.50 | Buy: 306.80 | Change 3.00 (0.98%)
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Royal Mail's first half revenue grew 9.8%, as growth in parcel and international revenue offset a decline in letters. However, underlying operating profit fell 77.6% to £37m, reflecting higher operating costs associated with the shift to parcels and restructuring costs.

The shares rose 6.6% in early trading.

View the latest Royal Mail share price and how to deal

Our View

The huge increase in online shopping has seen a rapid increase in the number of parcels making their way to our doors. Royal Mail's played a key part in that process and that's boosting revenues at both home and abroad.

However, the group hasn't escaped coronavirus unscathed. Letter volumes have collapsed, led by a dramatic decline in advertising mail. Extra costs associated with servicing the unexpected parcel demand make increased revenues as much a burden as a blessing in the short term. Combine all that with a potentially painful recession and losses in the UK division have begun to mount.

While a pandemic might have been unforeseeable, the current crisis is highlighting 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 and watchful regulator that have, 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, but an operating margin of 8.9% is far better than the losses suffered 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 has already cut more than 2,000 roles, suggesting he is prepared to make unpopular decisions. Other operating costs are also under the 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 are being delayed or trimmed a little 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. 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 at the moment, but with several years heavy investment to come it won't stay that way.

It's hard to overstate the challenges Royal Mail faces. Shrinking the cost base, investing in technology and adding to international acquisitions are, in our opinion, the right answers. However, identifying the solution and executing the plan are very different things, and Royal Mail's track record doesn't inspire confidence.

Royal Mail key facts

  • 12m forward Price/Earnings ratio: 25.2
  • Average 12m forward Price/Earnings ratio since listing (2013): 12.5
  • Prospective yield: 0.9%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

Royal Mail's UK business saw revenues rise 4.9% to £3.8bn. This reflects a 20.5% decline in letters revenue to £1.5bn and a 33.2% rise in parcels revenue to £2.3bn. Both addressed and marketing letters were down, while management attributed the rise in parcels revenue to the lockdown e-commerce boom.

Operating costs rose 10.7% to £4.0bn due to COVID-19, the shift from letters to parcels and restructuring costs - mainly management redundancies. As a result the division made an operating loss of £129m, compared with a profit of £75m last year.

GLS revenue rose 21.7% to £1.9bn, reflecting growth in most regions thanks to a rise in e-commerce. The division made an operating profit of £166m.

Net debt fell from £1.1bn to £1.0bn, primarily reflecting £188m in free cash flow, down from £245m last year.

Royal Mail has updated its forecasts to account for higher than expected parcel growth. UK revenue is expected to rise by between £380m and £580m, and if it exceeds this level management expects the UK business to be profitable. Growth expectations have also been raised at GLS from 10-14% to 21-23%.

Find out more about Royal Mail shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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 disclosure for more information.