In 2014, a year after Royal Mail Group [RMG] debuted on the stock exchange at a 330p share price, UK lawmakers lambasted its advisors for allegedly undervaluing the stock by as much as 9%. Five years on from privatisation, however, and the company’s share price of 209p on Monday’s close is a third less than the original valuation.
Royal Mail shares dipped below their IPO price for the first time in October last year as a profit warning compounded the general rout on the London bourse. The news, delivered on 1 October, sent the share price down 27.4% that week. Currently, the company is down 55% year-on-year and 23.3% year-to-date.
Decrease of Royal Mail's share price year-on-year
The performance of the stock, which keeps hitting new record lows, has led to a majority ‘hold’ rating from analysts. Others, like Deutsche Bank, see the stock as overvalued even at its current levels, saying in June that there were “no easy short-/medium-term fixes” for the business.
Transitioning to a publicly-traded company was supposed to help Royal Mail grow into a global logistics powerhouse while enjoying its position as an erstwhile monopoly on postal infrastructure in the UK. Instead, the company’s current predicament puts its consensus forward PE ratio at just 8.7, behind the Netherland’s PostNL’s [PNL] of 9.39, while it is considerably lagging the Deutsche Post’s [DPSGY] ratio of 14.64.
So, where has Royal Mail gone wrong – and can its share price rally from record lows?
Letter volumes drop
Management has been blaming much of Royal Mail’s woes on the shrinking letter delivery business across the UK. Letters volume was down 8% in the year to March, while total letter revenues dropped 6%. Furthermore, a recent Royal Mail-commissioned PwC report predicted letter volume will fall on average approximately 4.6% per year to 2028, from 10.3 billion letters a year in 2018 to 6.2 billion in 2028.
According to the latest annual report, the decline in letters volume has been “primarily driven by e-substitution” (in other words: people and businesses communicating via e-mail rather than physical paper), as well as a decline in marketing mail revenue “largely reflecting the impact of GDPR”.
Therefore, the only way Royal Mail can sustain profits within letter delivery is by reducing costs, for example, through automation. Even achieving that task, however, is an uphill struggle. In October’s profit warning, the company said it would only achieve some £100m in cost savings, lowered from a forecasted £230m. “Those efficiency gains remain central to the Royal Mail investment story, and if they can’t be delivered then there’s nothing to protect the group from the pains of an economic downturn in the UK,” Nicholas Hyett of Hargreaves Lansdown told Proactive Investors in January.
“Those efficiency gains remain central to the Royal Mail investment story, and if they can’t be delivered then there’s nothing to protect the group from the pains of an economic downturn in the UK” - Hargreaves Lansdown analyst Nicholas Hyett
A productive workforce
Royal Mail workers were collectively awarded a 10% stake in the business when it floated six years ago, but the profit warning left many out of pocket just as they planned to sell, according to reports at the time. A disgruntled workforce makes it all the more difficult for the company to achieve the productivity targets it set for itself. According to New York broker Jefferies, increased output would do little to counter rising people costs, particularly after a labour agreement last year which saw working hours capped at 37 hours week.
Consistently through recent updates, the parcel business at Royal Mail shone as one of the few growth areas. The company is aiming to ride the growth in cross-border ecommerce business, hoping that revenues from parcel delivery will offset the fall in revenues from letter delivery.
In May, chief executive Rico Back told Reuters he wants parcel delivery to account for 70% of revenues, and for operations outside Britain to bring in 40% of revenues within the next five years. Currently, both of those measures stand at 25%. Back’s announcement that the company would reinvest £1.8bn to make that happen sent the company’s share price up 9% that day to 231p.
At the same time, entering the ecommerce space means having to face Amazon [AMZN]. In May, analysis from UBS found that for parcels below 2kg Amazon already offers the cheaper alternative to Royal Mail, with analysts telling Proactive Investor that to compete with Amazon, Royal Mail would need to “find ways of reducing its cost of parcel fulfilment”.
|PE ratio (TTM)||11.94|
|Return on Equity (TTM)||3.86%|
Royal Mail share price vitals, Yahoo Finance, 30 July 2019
Royal Mail’s reiteration of its outlook for the 2019-20 financial year in July did little to console investors. In January, it forecasted adjusted operating profits of £300-340m versus £509m the previous year, while also announcing a 40% dividend cut to 15p.
Furthermore, Deutsche Bank analysts were recently reported by Proactive Investor as saying they didn’t believe that Royal Mail could reach its profits target of £600m for 2023-24, predicting instead only £420m. Other cases of privatisation of postal operators in Europe may now provide a painful roadmap for what’s to come.
The Deutsche Bank analysts pointed to instances when European postal services had typically overlooked shareholders as cash flows were “diverted to employees, complex restructuring/modernisation and M&A,” resulting as they said in “periods of material share price underperformance,” and leading them to cut their target price from 180p to 150p.