Royal Mail profits almost double prompting 5% rise in share price.

27th November 2013


Royal Mail reported an operating profit of £283 million for the six months to 29 September prompting shares to rise as much as 5% in early trading to 563p. Operating profit has increased by £144m for the same period last year. A one-off VAT credit of £35m helped bolster profits. Parcel revenue increased by 9% to £1.48bn and now accounts for around 40% of postal revenue. Group revenue grew by around 2% on the back of this increase.

The firm will propose a final dividend, to be paid in July 2014, of £133 million. This amount is approximately two-thirds of the notional full-year dividend of £200 million that the directors believe they would have proposed if Royal Mail had been listed throughout the financial year 2014. Group net debt has been reduced by £183 million from 31 March to £723 million as at 29 September.

Moya Greene, Royal Mail’s chief executive, said: “Our first-half financial performance was in line with our expectations of delivering low single-digit revenue growth and margin expansion.”

Shares are now around 70% higher than the 330p at which the government sold the shares in early October. The market value has increased by £2.2bn since the flotation, which valued Royal Mail at £3.3bn. This is certain to keep up the pressure on ministers particularly business secretary Vince Cable who is speaking to MPs this morning about the float.

Broker Hargreaves Lansdown has issued a stock note along with the Royal Mail results. Richard Hunter, Head of Equities says: “Royal Mail’s opening numbers have met with a warm reception, despite increasingly loud whispers of valuation concerns. Gradual but terminal decline of the letters business is an on-going challenge, whilst the dividend yield has suffered as a result of the share price appreciation – standing at an estimated 3.5%, it is a reasonable yield given the current interest rate environment, but not at the level of some of its competitors. The combined UK Parcels and GLS divisions now account for just over half of group revenue which provides both opportunities as well as potentially inviting more entrants into a fiercely competitive space. That being said, most of the key metrics are moving in the right direction, helped along by a tight rein on costs, lower than expected transformational expenditure and a focus on the important area of margin expansion. The share price rally since flotation is central to the investment case from here. Prior to today’s update, the shares had jumped 62% from the offer price, and 18% from the first price on the opening day of trading.”

HL says the very limited market consensus is that the shares are up with events and comes in at a straight hold.

HL has listed a range of negative and positive points surrounding the shares which we include below.

·         Letter volumes continue to decline.

·         The parcel markets in the UK and Europe in which the Group operates are highly competitive. The Group may be adversely affected by parcel operators that successfully capture some of the Group’s market share.

·         It is the UK’s designated universal postal service provider and delivers a “one price goes anywhere” service on a range of parcel and letter products in the UK 6 days a week. In future it may not be able to recover all of its costs, including the costs it incurs in providing the universal postal service. Furthermore, as the designated Universal Service Provider in the UK, it is bound by certain regulatory obligations.

·         There is a risk that one or more material disagreements or disputes between the company and the trade unions could result in widespread localised or national industrial action. National strike action and other forms of industrial action may take place across the whole of the company’s UK Parcels, International and Letters Division’s activities in the UK near term.

·         The group’s performance and results of operations are significantly influenced by macro-economic trends and conditions.

·         The group’s business is labour-intensive and necessitates a large workforce. The size of, and high fixed employment costs associated with, the company’s workforce in the UK may make it less competitive compared with other postal operators in the UK.

·         A large proportion of the group’s IT applications, systems and infrastructure in the UK are ageing and will require further investment and improvement in the future in order to deliver the capability to continue to support the group’s UK operations.

·         Royal Mail employs approximately 150,000 people in the UK on a full time basis. About 80% of the workforces are members of a union, principally the Communication Workers Union (CWU). Union members recently voted for strikes and while Royal Mail is currently in negotiations with the CWU over a new pay deal, the risk still remains. Industrial action could have a material impact on its business operations.

·         Dividends are not guaranteed and, if payable, may vary.

Positive Points:

Royal Mail is well placed to benefit from the growth in online shopping, fulfilling the parcel deliveries – the so called “last mile”.

It is the leading provider of postal and delivery services in the UK, with significant operations in continental Europe.

It has an established brand, household name and a UK wide network.

The group has a significant London property portfolio that includes a 14 acre site in Nine Elms, South London, an acre site at Mount Pleasant, Royal Mail’s central sorting centre, and a 1 acre site at Paddington train station.

The Group’s pre-1 April 2012 pension liabilities (based on service and pay up to that date) and certain pension assets relating to the Royal Mail Pension Plan have been transferred to the Government.

Royal Mail has been undergoing a transformation programme since FYE 2008 focused on enabling it to deliver letters and parcels more efficiently and adapting the Royal Mail Core Network so that it can carry more parcels.

The company has increased operating profit margins over the last three years.

Further efficiency measures and streamlining could increase profits.

With a stock market valuation of over £5.0 billion (26th Nov 2013), the company is likely to prove eligible for entrance into the UK’s premier FTSE-100 index.

The company intends to pursue a progressive dividend policy. In respect of FYE 2014, and in the absence of unforeseen circumstances, the Directors intend to propose a final dividend only, to be paid in July 2014, of £133 million. This amount is approximately two-thirds of the notional full-year dividend of £200 million that the Directors believe they would have proposed if the Company had been listed throughout FYE 2014.

The Royal Mail can trace its history back to 1516, when Henry VIII established a “Master of the Posts”, a position that was renamed “Postmaster General” in 1710. Today Royal Mail employs around 150,000 permanent postal workers and is required by law to maintain a universal service for addressed mail in the UK, delivering letters 6 days a week to over 29 million addresses around the country. It is also the UK’s largest parcel delivery service.

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