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Royal Mail - stalled savings mean losses mount

Weaker retail trends, fewer test kit deliveries and a structural decline in letters meant revenue fell 5.1% to 3.0bn pounds in the first quarter.

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Weaker retail trends, fewer test kit deliveries and a structural decline in letters meant revenue fell 5.1% to £3.0bn in the first quarter. This reflected an 11.5% decline in Royal Mail revenue which more than offset a 7.8% increase at GLS.

With the union refusing to support this year's efficiency targets, £100m of the planned £350m in cost savings is under pressure. Underlying operating profits are now seen breaking even if Royal Mail can make progress on efficiency improvements that do not require union agreement.

Moving forward the group will now be called International Distributions Services plc. This won't change the structure of the business, but reflects an increased focus on the GLS arm. If Royal Mail can't significantly improve its operation, the board is open to splitting the two sides of the business.

Shares were down 4.8% following the announcement.

View the latest Royal Mail share price and how to deal

Our View

Royal Mail hit a brick wall with union negotiations and that's put the brakes on its efficiency improvements for the foreseeable future. The group's now pinning its hopes on its smaller, international, business GLS - driving a name change to International Distributions Services. If all else fails, the board said it's open to splitting into two separate businesses.

While the road ahead looks bumpy to say the least, if GLS and Royal Mail part ways, neither will have an easy ride. Royal Mail's bloated cost structure will continue to be a ball and chain and GLS, while profitable, will struggle against deeper-pocketed competitors. At present the split's just a hypothetical, and it could be a tactic management's using to inch forward in union negotiations.

Together, the two arms are struggling to keep the business from sinking. GLS is expected to deliver mid single-digit revenue growth over the next few years, with margins around 7%. For now, the group's confident it can navigate the inflationary headwinds with price hikes and efficiency improvements.

However, all of that depends on demand remaining intact, something that's far from guaranteed as macro conditions continue to wobble.

That will offset some of the pain coming from Royal Mail, which is essentially stuck in limbo until it can reach a consensus with the union. The group's seeing roughly £1m per day walk out the door, as it's been unable to trim its cost base to keep up with falling post-pandemic demand. While management's committed to making changes that don't need union approval, almost a third of this year's cost savings are linked to union negotiations.

The group's marching on with its automation drive, on track to automate 70% of parcels by the end of the year. In theory this should make the group's cost base more flexible to cope with changing demand patterns. But it's a drop in the ocean if costs remain the same. It's also an expensive endeavour- at last check the group was planning to spend around £350m this year.

Plus, the group's heading into a more difficult environment. Pandemic-related tailwinds are gone and the outlook for ecommerce is deteriorating.

If the group can't pare down its costs in line with shrinking demand, it will likely take a toll on the group's prospective yield of 7.4% at some point, which is high due to the share price decline. If the current situation persists, it wouldn't be surprising to see shareholder returns on the chopping block. As always there are no guarantees.

With that said, it's in no one's best interest to drive Royal Mail into the ground. Nothing is yet set in stone, and we could see relations improve in the months ahead. In that, albeit unlikely, scenario Royal Mail shares could rerate. However, with a PE ratio well below-the long-term average, the market's not overly optimistic.

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.

First Quarter Results

Revenue at Royal mail fell 11.5% to £1.9bn reflecting volume declines in all segments. Total parcel volumes fell 15%, though this was 1% higher than pre-pandemic levels. Letter volumes declined 6% year-on-year and 23% on a two-year basis. The group's been unsuccessful in gaining union approval for this year's efficiency improvements, which meant costs remained elevated despite the drop in volumes. This led to a £92m operating loss.

GLS saw revenue rise 7.8% to £1.1bn despite a 3% volume decline due to price increases and fuel surcharges. Margins were hurt by inflationary headwinds, as expected, but the group continues to expect full year operating profit between €370m and €410m.

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
Laura Hoy
Laura Hoy
ESG Analyst

Laura is part of HL's ESG analysis team, working to offer research and analysis to help with sustainable decision making. She also works with other parts of the business to help integrate ESG.

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Article history
Published: 20th July 2022