RM grows profit & dividend

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Royal Mail full year results show a better than expected performance from UK Letters and a good performance from European parcels, offset by competitive pressures in UK Parcels. Overall, Group revenue increased by one per cent to £9,424m. Adjusted Group operating profit before transformation costs increased by 6 per cent to £740 million, with underlying margins 40 basis points higher. The group said it remains committed to growing the dividend - which it raised by 5 per cent. Having recently had a strong run, the shares were trading 1-2% lower following the announcement.

Key highlights:
UK Parcels, International and Letters revenue was flat at £7,757 million. A one per cent decline in total letter revenue was offset by parcel revenue growth of one per cent, reflecting competitive market conditions.
UKPIL parcel volumes increased by three per cent. Addressed letter volumes declined by four per cent, at the better end of the group's forecast range.
The European parcels business - GLS (almost a fifth of Group revenues), continued to perform well with revenue up seven per cent to £1,653 million and volumes up eight per cent.
Free cash inflow increased to £453 million, benefiting from £100 million of net cash flows from the London property portfolio.
Net debt reduced from £555 million to £275 million.

Transformation and cost control:
Driving cost and efficiency savings remains a key priority. Productivity improved by 2.5 per cent in 2014-15, within the target range of 2-3 per cent per annum. The management reorganisation programme delivered cost benefits of £42 million. It is now expected to deliver cost savings of around £80 million per annum from 2015-16 - better than the £50 million annual savings originally anticipated.

Outlook:
The parcels and letters markets in the UK remain highly competitive. Royal Mail continues to estimate that volume growth in the parcels market will be reduced to around 1-2 per cent per annum in the short term, reflecting the impact of Amazon using its own delivery network more. UK addressed letter market volumes are expected to decline by 4-6 per cent per annum in the medium term.

The group is guiding for a reduction in GLS margins by around 50-100 basis points in 2015-16, due to the combined impact of German minimum wage legislation and the disposal of its subsidiary.

The group is targeting flat or better UKPIL underlying costs for 2015-16. It continues to expect on-going transformation costs of around £120-140 million per annum depending on the level of voluntary redundancies announced in-year.

Moya Greene, Chief Executive Officer of Royal Mail commented:
"Our trading environment remains challenging, but we are now poised to step up the pace of change to drive efficiency, growth and innovation, while maintaining a tight focus on costs.

"At this early stage of the financial year trading is in line with our expectations, but as in previous years our performance will be weighted to the second half and will be dependent on our important Christmas period.

"We remain committed to delivering value for our shareholders and the Board is recommending an increase in the full year dividend of five per cent."

Our view:
Royal Mail shares have been volatile since their IPO. Having almost doubled from their initial launch price of £3.30, the shares fell to around £3.90 in the second half of 2014. In recent months they've staged something of a recovery, but still remain well below their peak.

This volatility has stemmed from concerns over intensifying competition, which has seen growth in the UK Parcels business grind to a halt. Amazon's entry into the UK delivery market reduced Royal Mail's addressable market by about 3%. The demise of competitor City Link, in late December, illustrates how fiercely competitive the UK parcel market is, and Royal Mail expects conditions to remain challenging.

The outlook for the UK Letters business may be improving. Rival Whistl (was TNT) has announced it is suspending its 'end-to-end' delivery service, and has commenced an "extensive review" of its feasibility. Royal Mail had previously warned that growing competition from direct delivery operators such as Whistl could reduce its revenue by over £200m in 2017-18. The issue has not gone away (the regulator is still keen to promote competition and is currently reviewing access pricing), but this is clearly a welcome development for Royal Mail.

The European parcels business continues to perform well and the group appears to be making good progress with its cost saving initiatives. Having spent so long in public hands there is little doubt efficiency savings are there for the taking, which could help drive margins higher. Cash generation is also strong; property disposals from the large London property portfolio contributed £100 million of net cash flow in FY15 and further disposals are likely over the coming years.

Those strong cash flows enable Royal Mail to pay healthy dividends, underpinning a prospective yield of 4.2% (variable and not guaranteed). Following today's 5% rise, the group has said it remains committed to growing the dividend. The yield is a major attraction in the current environment.

If Royal Mail can succeed in reducing its operating costs and improve the growth rate for the parcels business, then future dividend growth prospects ought to be encouraging, given the strong cash flows already being generated.