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Royal Mail - revenue increases as volumes slow

Nicholas Hyett, Equity Analyst | 23 September 2021 | A A A
Royal Mail - revenue increases as volumes slow

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Royal Mail PLC Ordinary GBP0.01

Sell: 273.10 | Buy: 273.50 | Change 1.60 (0.59%)
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In the five months to August, revenue rose to £5.1bn, up 8.2% from a year ago and a 17.7% increase compared to 2019. This reflected revenue growth at both GLS and Royal Mail plc despite a decline in total parcel volumes from 2020.

The pandemic continues to cloud growth forecasts, but the group expects first half operating profits to be between £395m and £400m, well beyond 2020 levels.

The shares were broadly flat following the announcement.

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Our View

The pandemic was a huge boost for Royal Mail, but those tailwinds are starting to dissipate.

Parcel volumes have declined from last year's highs, but crucially appear to be rebasing at a much higher level than pre-pandemic. Much of the decline can be attributed to the short-term lockdown-related spike--but there are other factors at play too. Management called out some supply chain issues that are, in theory, temporary.

However, RMG has managed to spin gold from hay. Despite declining volumes, the group's expecting first half operating profits well beyond 2020 levels. That's due in part to rising prices, but also the resolution of last year's struggles to keep up with demand. Costs ballooned as the postal service worked to push an unprecedented number of parcels through the network. Management's been quick to address shortcomings, with a long-overdue update to RMG's sorting facilities.

Investment in parcels infrastructure is set to rise with capital expenditure expected to be well over £400m next year in the UK alone. Construction of a new, fully automated parcels hub in the Midlands is underway, capable of sorting over a million parcels a day by 2023. That should help resolve what we see as a history of chronic underinvestment - just 33% of UK parcels are currently sorted by machine versus an industry benchmark of 90%.

Recent agreements with unions have also created more predictable labour costs and the group's committed to bringing down overall operating expenses outside of wages.

At the PLC level, Royal Mail also benefits from the strength of its international business GLS. It's historically the fastest growing part of the business and has managed to remain robustly profitable throughout the crisis. Relatively modest spending requirements going forwards mean it's a blueprint the group would love to emulate in the UK.

As conditions start to normalise, shareholder returns are rolling again, with a progressive dividend policy going forwards, albeit starting from a lower level than what was paid in 2019. A year of bumper sales, lower dividend payments and reduced capital expenditure means the balance sheet is in remarkably good shape exiting the pandemic. Although with several years of heavy investment to come, it won't stay that way.

Shrinking the cost base, investing in technology and adding to international acquisitions are, in our opinion, the right answers long term. Future parcel volumes look likely to remain elevated, though not at pandemic highs, while letters are in terminal decline. But the group's well-placed to capture the opportunities open to it. A price to-earnings ratio some way below the long run average, and a prospective dividend yield over 4% is encouraging for what has long been an unloved stock.

Royal Mail key facts

  • Price/Earnings ratio: 7.8
  • Average Price/Earnings ratio since listing (2013): 12.6
  • Prospective dividend yield (next 12 months): 4.6%

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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Trading Update

Revenue for the five months to August at Royal Mail rose 7.2% to £3.5bn, a 12.1% increase from pre-pandemic levels. Total Parcel volumes declined 12% year-on-year, the result of reduced international shipments due to customs processing issues and lower air freight capacity. Domestic parcel volumes declined to a lesser degree and revenue rose 4.1%.

Letter volumes grew 13%, but the ongoing structural decline continued with volumes down 19% compared to 2019. A favourable price mix meant Letters revenue rose 18.3% to £1.5bn, but this was still 7.3% below pre-pandemic levels.

Royal Mail's second half operating profits are forecast to outpace the first six months of the year, helped by seasonal trends, a new union agreement, and a cost reduction programme.

In the five months to August, revenue at GLS rose 9.3% to £1.7bn, a 30.5% increase from pre-pandemic levels. That was offset by movements in exchange rates, without which revenue would have risen 13.6% and 34.8% respectively. This reflected a 9% year-on-year increase in volumes and increased prices.

Inflationary pressures within the division aren't expected to derail the group's previous forecast for low single digit revenue growth and operating margins around 8%.

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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.