Royal Mail at crossroads – new directions or lost up the garden path

19th November 2014


By Tony Levene

As Royal Mail reveals half year results, investors in the group – controversially privatised in October 2013 – face a dilemma. Should they sell out now while the shares are still around 30 per cent higher than their IPO price? Or should they ignore warnings that competition is eroding the one time monopoly and trust in the management to see off the newcomers?
The results themselves are less than scintillating. Turnover is up just 2 per cent – in line with inflation – to £4,525m. That’s less than some of its own price rises so business volume is sliding. And while the market reaction was initially flat, the shares were down as much as 8 per cent to 431p following the analysts meeting with management.
There’s a whole lot of other numbers but the essential profit before tax is down from £233m to £218m – and the first time interim dividend is 6.7p per share.

So what do investors have to weigh up?

The negatives

Amazon’s development of its own lower than drones technology delivery service gets the top highlighting. It will probably erode around 2 per cent of its business but with margins as tight as they are, this is significant.
Other parcel delivery services such as MyHermes, DPD and TNT-Whistl are considered cheaper, and more flexible. They are snapping at its heels, forcing it into Christmas period price reductions on parcels. They are also increasing capacity which poses a problem as they accept they will have to price low for some time to justify extra staff and premises.

Consumers and businesses dislike the Royal Mail pricing model, which looks at size as well as weight (even if this is now acknowledged to be a mistake). Royal Mail has an image problem here, which it believes could take five years to turn around.
The Universal Service Obligation – Royal Mail must offer six days a week delivery to every UK household. Rivals such as TNT-Whistl do not. Whistl is cherry-picking areas of high residential density for its own delivery service, which has had teething troubles but will learn from them. The competition does not bother delivering in rural areas where costs are much higher. Whistl has around 14 per cent of addressed mail volumes in areas where it delivers. Overall, letter competition has taken around 6 per cent.
Addressed letter volumes are still declining – with a number of major senders such as banks switching to cheaper rivals even if not for that last mile to consumers’ homes. But the rate of decline has slowed.

The positives

Royal Mail management is lobbying hard for the removal or adjustment of the universal service obligation. It is difficult to argue against the view that imposing this on one operator while allowing others to pick and choose is unfair. It would, however, be politically difficult for a future government to backtrack on this.

It hopes to revive addressed mail volumes by telling businesses that sending personalised mail has more effect on customer choices than emails which are easier to ignore or delete. It is also campaigning against firms which charge customers more to pay through the post than online.

It hopes to become more flexible with Sunday working at some offices – it wants to avoid the bad image from the long queues around streets as people picked up parcels last Christmas.

It has become much more aware of competitor pricing. And of competitor offers. It has developed links with eBay and PayPal and working on more click and collect services. It is improving and increasing delivery to neighbour and local collect services.

It is unwinding the unpopular size based pricing model.

Online shopping continues to increase.

Senior management continues to impress major investors.

What do the analysts think?

Prior to the results, out of 26 analysts polled by the Financial Times, eight said buy or that the shares would outperform, seven said sell or that the shares would underperform while 11 said hold. Opinion was evenly split. Following the figures, the balance is unlikely to change as some will see the lower share price as an opportunity while others as a warning.

Darren Hepworth, Director of Global Trading at TD Direct Investing says:
“It has been a year of changing fortunes for Royal Mail, following the initial speculative bubble – driven in part by the cries that the IPO had been undervalued. Shareholders benefited from the peak in price in early 2014 (618p, up almost 90% on list price) with sales of Royal Mail then making up 77% of all our trades. Subsequently, the price has fluctuated, regularly dropping below the 400p mark. The settling of the competition case against its French parcel delivery firm, GLS, in October has provided a much needed boost, increasing share price by almost 20%.”

And Chris Beauchamp, Market Analyst, IG adds:

“The spectre of Amazon looms large in Royal Mail’s numbers today, casting a shadow over the numbers. A 6% decline in pre-tax profits to £218 million is one thing, but the warning about reduced parcels growth will send a winter chill down the spine of investors. The impression given from the statement is that Amazon is likely to become a permanent fixture in Royal Mail’s reporting, much like the weather (whether warm or cold) is for retailers.

“Increases in operating profit margins will offer some comfort, while the boost in letter volumes will help too, even if this is partly influenced by election campaign volumes that won’t recur every year. However the statement finishes on a cautious note, admitting that Christmas will be the key determinant in overall performance. Christmas comes but once a year, so investors need to ask themselves if they really want to back a company that only really delivers good performance thanks to a six-week busy period?”


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