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International Distributions Services - ongoing strike woes cloud

IDS has said Royal Mail is expects to deliver a half year underlying operating loss of £219m...

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IDS has said Royal Mail expects to deliver a half year underlying operating loss of £219m, compared to profit of £235m last year. The losses include a £70m hit from 3 days of strikes.

For the full year, losses are expected to be £350m, because of the effect of further industrial action. Losses could widen if the disruption causes a more permanent shift in customer losses. If the threat of 16 days additional industrial action takes place, losses would increase ''materially''.

The group's announced plans shrink Royal Mail's workforce by some 10,000 before the end of August 2023 to cut costs, and is unable to give a clear outlook for the current financial year.

The group confirmed that trading at its international parcel delivery network GLS is trading in line for the first half of the financial year.

The shares were down 12.4% in early trading.

View the latest International Distributions share price and how to deal

Our View

Industrial action at Royal Mail has severely impacted the Group's ability to resize its operations in the face of falling volumes. This then becomes a vicious circle, with volumes taking another lurch downwards while strikes happen, and the prospects for Royal Mail worsening further.

Until a way forward is found, the outlook appears precarious. At the March year-end the group had net current assets of £276m, a key metric of short-term financial health. Even if performance holds up at GLS, the Group's International Parcel Network, it seems likely that IDS will be below cash-flow break even for the current financial year. Depending on how hard the Communication Workers Union digs in its heels, the cash outflow could become material.

Excluding operating leases, IDS had net cash of £307m at last count. This position is likely to deteriorate in the current financial year. How much exactly is in part connected to how co-operative the union is. An important near-term event for the Group is the pending repayment of £416m of bonds in 2024. As these fixed rate bonds expire, the average interest rate on the company's borrowing is likely to go up.

Then there are likely to be one off costs associated with downsizing at Royal Mail. Assuming redundancy costs of £30k per head (our best guess) redundancy costs alone could total £180m based on a possible 6,000 redundancies.

Royal Mail's ongoing problems could threaten the availability of its borrowing facilities which require net debt to be no higher than 3.5x cash profits. The facilities also require net debt to be no more than 3.5x interest payments. We believe these are hard targets to meet currently, and there is a risk that the 8% prospective yield will not materialise.

Given the uncertainty there could be challenges to any refinancing, be it debt or equity. Investor enthusiasm is unlikely to return until further clarity emerges.

There are some bright spots. We're encouraged that GLS is trading in-line with expectations, and we believe there are some long-term growth opportunities in this division. Keep in mind that broader conditions might create some near-term challenges.

Then there's always the possibility that Royal Mail is able to strike a deal with its union. If this happens, the company's valuation could re-rate substantially. Those willing to accept the heightened risks could be rewarded should IDS emerge as a more efficient streamlined business.

There has been talk of GLS and Royal Mail splitting, but this is by no means guaranteed. If Royal Mail can return to sustained profitability it may make sense to keep them together. If it can't there are real questions as to what an exit might look like. We're cautious about the road ahead.

Royal Mail key facts

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.

International Distributions Services trading update and revised outlook (All references below are to Royal Mail)

Royal Mail revenues were down 10.5% in the first half to £3.6bn, driven largely by double digit declines in all of its parcel divisions. In comparison to 2019 Royal Mail revenues were down just 0.1%.

Whilst first half Total Parcel volumes were flat against pre-pandemic levels, they were down 15% year on year. This equated to a total year on year revenue decline for parcels of 14.4% to £2.0bn.

Domestic Parcels volumes had the sharpest volume fall, down 16% to 539m items.

International deliveries were down 6% and 42% against pre-pandemic levels with a total of 74m deliveries.

Meanwhile, Royal Mail made 3.6bn letter deliveries, down 6% over 2021 and 24% against the same period in 2019.Revenues from this segment were down 5.3% over 2021 to £1.7bn, or 13% over 2019.

At Royal Mail underlying free cash outflow for the half year swung from a £114m inflow to an outflow of £274m.

The ongoing industrial action increases the risk that it will write down the value of Royal Mail, which is currently recorded as £1.37bn. It will update further at the half year results next month.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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.

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Written by
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 14th October 2022