Where is the Royal Mail share price heading?

It could well be fair to say that Royal Mail’s [RMG.L] share price has singularly failed to deliver for investors this year, not unlike its postal service in some parts of the UK, as staff absences continue to hit the company.

There are other clouds on the horizon too for Britain's premier postal service and courier firm, with fears over the company’s profit outlook over the medium term. But with the shares having fallen over 40% in less than 12 months, does the stock’s currently low valuation outweigh the company's apparent lack of growth prospects?

What’s happening with Royal Mail’s share price?

It’s been a torrid 2022 so far for the Royal Mail share price, which has plummeted 30.12% already this year, and that’s after the stock postmarked a positive few days to close out last week up 7.44% at 353.60p. Looking slightly further back, the shares have sunk 42.4% from the 52-week high of 613.80p, reached on 7 June last year.

Headwinds hamper ability to deliver

In a clear signpost to investors earlier this month, Barclays cut its price target on Royal Mail’s share price from 640p to 400p, due to current uncertainties and active trade union talks, while also cutting its full-year earnings estimate by 40%, citing weaker trade prospects. Barclays’ analysts said it would be a “challenging transition year” for the company.

Ongoing Covid-19 related staff absences have continued to impact services, causing delays in some areas of the country, notably Kettering. The postal and courier service faces a myriad of other headwinds, namely a soaring inflation rate, plus rising supply chain costs, coupled with a long-term decline in letter posting. The volume of letters posted has fallen by over 60% since 2004–05, and is 20% weaker since the start of the pandemic, report Motley Fool. These issues prompted Royal Mail to raise the cost of first and second-class stamps on 4 April, with first-class stamps going up by 10p.

These factors have led to escalating concerns for the company’s growth potential, with earnings forecasts to decline by an average of 2.6% per year over the next three years. Adding to the list of issues Royal Mail is facing, the Communication Workers Union has requested additional pay increases of around 5%, in the face of fast-rising inflation. With operating margins at only around 8%, Motley Fool’s Zaven Boyrazian reckons agreeing to the demands “could have dire consequences on profitability”. The possibility of strike action can’t be ruled out, so it’s clear Royal Mail is facing a testing time, and its share price decline is reflecting the uncertainty.

Royal Mail moves to address issues

The company is working to resolve its service issues and meet growing parcel and online demand, and has installed an automated parcel sorting machine at its Southampton depot, as part of a multi-million pound investment programme to replace physically demanding manual sorting processes. The machine is able to automatically process 157,000 parcels per day.

Some 39 parcel sorting machines are due to be in operation by October 2022, including new hubs in Warrington and Daventry, which should process more than 1.5 million parcels per day. The ongoing automation programme will help Royal Mail meet increasing demand and should address some of the service issues it’s been experiencing. InvestingCube’s Kelvin Maina reckons the news helped Royal Mail’s share price gains last week.

Low valuation appeal

With a value of 380p, Royal Mail is fairly priced at just 7.47% below that level. However, Royal Mail’s high share price volatility relative to the rest of the market means that a bearish scenario could offer a “prime buying opportunity”, Simply Wall St reported.

Royal Mail’s current price-to-earnings ratio of 4.07 as of Friday 22 April’s close compares with an industry average of over 20, suggesting Royal Mail’s share price is considerably undervalued. The Motley Fool’s Dr James Fox agrees, saying recently that “the 3.1% dividend isn’t exactly world-beating, but I think the stock is trading quite cheap… the company is good value for money”.

Will Royal Mail’s share price deliver?

Despite a heightened level of uncertainty facing the company, last week’s share price upturn suggests “there is a high likelihood of the current bullish trend to continue”, according to Maina, who also says he expects “prices to rise and hit the 452p long-term resistance level in the next few days”. This would be a 27.83% jump from Friday’s 353.60p close.

Overall, Royal Mail has a consensus ‘outperform’ rating among 14 analysts covering the stock on ft.com, with four analysts rating the stock a ‘buy’, which compares favourably with just two ‘buy’ ratings in May 2021. Seven analysts have placed an ‘outperform’ rating on Royal Mail, with two ‘underperform’ and one ‘sell’ rating. In all, 11 analysts are positive on the stock, versus three negative ratings.

The 12-month price targets reinforce the prevailing positivity among analysts for Royal Mail’s stock’s prospects, with a median estimate of 550p representing a 55.54% potential upside from Friday’s close at 353.6p.