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Royal Mail - bumper Christmas, with profits upgraded

Nicholas Hyett, Equity Analyst | 11 February 2021 | A A A
Royal Mail - bumper Christmas, with profits upgraded

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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 reported a 20% rise in revenues in the third quarter, with record parcel volumes in both the UK and internationally and an improvement in letter volumes.

The group now expects full year underlying operating profits to be "well in excess of £500m", compared to £325m reported last year.

The share rose 5.2% in early trading.

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Our View

Royal Mail's third quarter results show a bumper Christmas.

Parcel volumes have boomed as consumers turned online for Black Friday and Christmas shopping. Royal Mail's premium 'Tracked' products saw sales rise 73%. Letters also staged something of a recovery - although remain down on last year. Price rises in both segments meant revenue performed even better.

But a bumper Christmas is no surprise in world where most shops are restricted to online sales and physically giving a gift to a friend or family member is essentially illegal in many cases. What is more notable in these numbers is the big upgrade in full year operating profit guidance.

The decline in high margin letter volumes earlier this year and extra costs associated with servicing the unexpected parcel demand made increased revenues as much a burden as a blessing earlier in the year. At the half year the group reported an underlying operating profit of just £37m. Christmas has been transformative.

Now the additional infrastructure is in place putting millions of extra parcels through the fixed cost base has dramatically improved parcel margins. A strong January and ongoing lockdowns suggest that trend will continue into the final quarter.

We can't help but wonder what happens to margins when the lockdown driven parcel surge dries up though. E-commerce may be the future of retail, but we are probably at a short-term high for parcel deliveries. For that reason it's good to see the group resolving some longer run problems.

Investment in parcels infrastructure is rising - with investment of a new, fully automated parcels hub in the Midlands capable of sorting over a million parcels a day. Agreements with its unions also help soothe long running industrial tensions.

At the PLC level Royal Mail also benefits from the strength of its international business. It's the fastest growing part of the business and has managed to remain robustly profitable throughout the crisis. It's a blueprint the group would love to emulate in the UK.

The combination of short-term uncertainty and long-term investment demands led the group to scrap its dividend this year. Management hope to get shareholder returns rolling again next year, but even with recent good news we'd expect it to be lower than what was paid in 2019. Royal Mail's balance sheet may be in relatively good shape at the moment, but with several years of heavy investment to come it won't stay that way, and keeping a bit more cash in house makes sense.

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. A strong Christmas 2020 is a good start - but still only the start.

Royal Mail key facts

  • 12m forward Price/Earnings ratio: 13.5
  • Average 12m forward Price/Earnings ratio since listing (2013): 12.7
  • Prospective yield: 2.5%

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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Third Quarter Trading Update

Royal Mail (the UK business) saw revenues rise 16.5% in the quarter, reaching £6.4m in the first nine months of the year. That reflects a 43.3% increase in parcel revenues (reaching £3.8bn over the nine months) and 8.5% decline in letter revenues (to £2.6bn over the nine months). Growth in both areas has improved on the first half, with revenues growing faster than volumes on positive pricing and product mix.

GLS (Royal Mail PLC's international business) saw revenues rise 29.4%, on a 27% increase in volumes. The group has seen an improvement in the previously underperforming French, Spanish and American and increased volumes has driven margin improvement.

Full Year revenue growth is expected to be "significantly" ahead of the £380m-£580m suggested in November. Given the impact of increased demand on service quality the group is retaining around 10,000 flexible workers taken on over the peak period and keeping four temporary Parcel Sort Centres open.

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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 for more information.