Royal Mail PLC (RMG) Ordinary GBP0.01
HL comment (21 November 2019)
Revenues rose 5.1% in the first half to £5.2bn driven by the international business, although the UK delivered its strongest result in five years. However, increasing costs in the UK meant underlying operating profit fell 13.2% to £165m. Management also warned that the UK business could be loss making next year following increased industrial action.
The group announced an interim dividend of 7.5p, down 6.3% year-on-year.
The shares fell 11.3% in early trading.
Royal Mail's selling point has always been that years of public ownership meant it had plenty of space to become more efficient. That would boost margins - helping profits grow even if revenues struggle.
Unfortunately disagreements with unions means those cost savings are proving harder to deliver than expected. And the cost of averting industrial action is increasing costs. Adding to the pain is a letters business which is struggling even more than expected - mainly thanks to a collapse in marketing mail. The combination of falling revenues and stubbornly high costs is stamping out UK profit margins.
There's better news from the international business. A few years ago we would have described this unit as small; but impressive growth, acquisitions and a struggling UK operation means it now accounts for the majority of profits. With UK profits potentially falling into negative territory next year, investors look set to find themselves more reliant on international mail to deliver the group's new dividend policy than they might like.
Against that background it's perhaps no surprise that CEO Rico Back has decided drastic action is needed. The group will be automating its UK sorting operations - with a particular focus on improving efficiency in the manual parcels sorting process. Along with existing spending plans, that will see the group invest £1.8bn in the UK postal system over the next 5 years.
The overseas business is also attracting attention, with investment behind organic growth as well as acquisitions. A focus on growing scale in B2B parcels underpins the division's target for revenue of €4.5bn by 2023/24.
Unfortunately all that extra investment comes at a price, and the first casualty has been the dividend. The payment to shareholders will be 40% lower this year than last, and the commitment to grow it has been scrapped as well. Although there's theoretically room for additional returns from time to time, don't forget that even the current 6.6% prospective yield depends on cash coming in as planned.
A manageable level of debt is in the group's favour, but major organisational restructures are expensive and risky. If the group continues to face major opposition from its employees that will only make the transition more difficult.
Half year results
The UK business, UKPIL, saw revenue rise 1.8% to £3.6bn, as 5.6% growth in parcels more than offset a 1.4% decline in letters. Parcel revenues reflect good growth in premium Tracked parcel volumes, while price increases helped offset a 5% decline in addressed letter volumes (or 8% excluding political mailings).
However, a 2.2% increase in productivity wasn't enough to offset increased staff costs, with overall operating costs up 2.9% as a result. As a result UK operating profits fell 33.6% to £75m.
Royal Mail's international business, GLS, delivered a better performance as revenues rose 14.1% on good volume growth. Operating profits from the division rose 16.9% to £90m.
The group finished the half with net debt of £1.4bn. That was significantly impacted by changes to the accounting treatment of leases, without which net debt would have fallen substantially to around £310m.
The group continues to expect operating profits of between £300m-£340m this year, although a weak economic environment and business uncertainty means letter volumes are now expected to decline by between 7-9%. Management now expects an increased rate of decline in letter volumes to continue into 2020-21. Combined with difficult industrial relations holding back productivity gains, this could see the UK business turn loss making next year.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. 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.
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