Royal Mail should start to deliver

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Royal Mail (LON:RMG) celebrated its IPO anniversary last month and after the early turbulence, the company appears to be stabilising after undergoing a move from public to private hands. The shares which listed at 330p last October, rocketed to 618p in January due to excess demand and over optimism, before settling back around 400p.

Royal Mail has two main businesses; UK Parcel, International and Letters (UKPIL), which generates 82% of revenue and General Logistics Systems (GLS), responsible for 18% of revenue. UKPIL, is offsetting a structural decline in the letter industry with Parcelforce, its fast-growing branded parcel delivery company and marketing mail operations.

Parcelforce has a market leading position, with 53% of deliveries, fuelled by an increase in internet shopping, while revenue from marketing mail benefitted from an improving domestic economy. GLS operates a parcel delivery operation across Europe, where tough competition caused profit margins to slip.

Privatisation of the 500-year old postal service has not been easy, with cost cutting and improving profit margins, proving harder than was expected at the time of the floatation. Its monopoly power and valuable assets, however, have shifted the group into a lower-growth utility type company, which has taken investors time to get their heads around.

Interim results on 19th November revealed a rise in revenue during the first six months of the year, resulting in a £279 million operating profit before extraordinary costs. The business generated £117 million in free cash flow and net debt was reduced to £590 million from £903 million last year.

Profits are likely to remain choppy during the turnaround, although shareholders will receive a 5% dividend yield, which is covered 1.5 times by earnings and more than twice by free cash flow, with a circa 8% increase in the yield expected during the next two years. The shares currently trade on 12.3x forecast earnings, a slight discount to its European peers and a wide markdown to the utility sector on circa 17x.

There is also hidden value in the London Development property portfolio, which was recently shown by the disposal of the Paddington site for £111 million in cash. Analysts estimate Royal Mail has net property assets of between £600 million and £1 billion, or 60p to 100p per share. The company had a net asset value of £2.7 billion or 270p per share at the end of September 2014.



The chart of Royal Mail illustrates the volatile journey during its first year, although the shares appear to be building a base around 400p. The oscillators have also started to rise out of acutely oversold territory, indicating an improvement in momentum.

Viewed more like a utility company, rather than a fast-growth stock, I believe Royal Mail offers attractive fundamentals, while improved innovation, with plans to offer a Sunday delivery service and automated parcel operations, should facilitate growth.

Neil Woodford, one of Britain's best-known fund managers, has bought shares in Royal Mail for his new fund and with a stop-loss below the recent lows at 388p, I believe it offers an attractive risk / reward bias. At the time of writing the share price is 405p, with near-term targets seen at 425.25p, 449.5p and 480p.