Royal Mail's "fair value" is 466p

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Royal Mail (RMG) should benefit from numerous tailwinds going forward, but its 68% gain in share price since listing fully reflects this, according to analysts at Barclays.

Following milestone regulatory changes and a landmark pension agreement, the postal company should profit from price flexibility, parcel volume growth and efficiency improvements/cost cutting, Barclays said.

However, its price of 550p at close of play on Tuesday was 18% higher than its base case "fair value" for the stock of 466p.

Susanna Invernizzi, analyst at Barclays, said: "Following last year's regulatory changes governing the UK postal sector, Royal Mail benefits from pricing flexibility around mal-products, allowing the group to raise prices and hence generate adequate financial returns despite declining letter volumes.

"Meanwhile, growth momentum in the parcel market is robust, thanks to rising e-commerce penetration and economic recovery."

On top of this, transformation and automation initiatives imply cost-cutting potential, and the group is in the midst of implementing a significant transformation strategy.

From this Barclays expects rising productivity and reduced costs, which will benefit the company's operating margins.

The resulting strong free cash flow generation of around £400 million per year for the next four years will fuel both dividend payments and deleveraging, with Barclays forecasting a reduction of 90% in Royal Mail's net debt.

Invernizzi continued: "Based on our sum-of-the-parts analysis, we identify a price target of 466p, which, on calendar 2014 would imply an EV/EBIT of 9.6 times (versus the sector at 9.4 times).

On our estimates, the current market price reflects more optimistic assumptions for volumes, restructuring and real-estate disposals, which, on our sensitivity analysis, could imply an upside fair case value of 575p.

"On the other hand, lower volumes and lower proceeds lead to our downside case valuation scenario of 334p."

Sell Royal Mail

Elsewhere on Wednesday, UBS, one of the banks that led the IPO of Royal Mail, urged clients to sell the postal operator, as it was now over-valued.

According to Sky News, which obtained a UBS research note on the stock, analysts set a price target of 450p and said the market was excessively optimistic about Royal Mail's prospects.

"We believe management has executed well on improving productivity, with the UK margin rising to 4.3% in 2012/13 from -1.6% in 2009/10. We expect further improvements due to productivity and revenue growth," the note said.

"However, with Royal Mail's share price up 68% since the IPO (versus 7% to 32% for peers) we believe the market is over-estimating margin upside. In particular we think it will be difficult to accelerate its transformation, given the limitations of the labour agreement."

The seven banks involved in the Royal Mail privatisation are now involved in a parliamentary hearing amid complaints it was undervalued at flotation.

Shares in Royal Mail dipped almost 3% in morning trading before recovering slightly to sit 1.75% lower at 540.5p.

Other potential weights on the stock came from continued uncertainty about industrial action and positive results from competitor UK Mail Group (UKM), which reported pre-tax profit up 63%.

UK Mail's parcel revenue was up 21.4% in the six months to 30 September, while mail revenues were down 0.3%.