The UK postal service is accelerating modernisation programme to deal with increased competition in parcels, says Questor
Royal Mail
476.7p +22½p
Questor says HOLD
Royal Mail [LON:RMG] may have reported lower revenue and profits yesterday but the shares rallied after it said there is more modernisation and cost-cutting to come. Perhaps more importantly, it has the full backing of the unions to do so. Questor believes the shares should be tucked away.
http://charts-cache.moneyam.com/telegraph/Chart.aspx?Provider=Intra&Code=RMG&Size=220*155&Skin=BlueBlue&Scale=0&Type=2&Cycle=MINUTE10&Layout=TelegraphMedium&E=UK&YFormat=&XCycle=Hour2&Fix=1&SV=0&Labels=0&Start=20151120Profit progress
When Royal Mail floated two years ago it was a long way from the finished article. The company still needed to reduce expenditure and increase efficiency.
The aim was to improve profit margins from around 4.5pc in 2013 to 7pc by 2018. That might not sound like much, but Royal Mail generates £9.2bn in revenue a year, so every 1pc is worth about £100m in operating profits.
At the interim stage, revenue was down slightly to £4.39bn for the six months to September 27 from £4.48bn at the same stage last year, while adjusted pre-tax profits fell 16pc to £240m, from £287m.
The reason for the decline was the cost of 3,000 staff leaving the business in the first half. The focus seems to have been on middle management, and with some taking voluntary redundancy, this resulted in “transformation costs” doubling to £94m. This is expected to rise above £180m for the full-year.
Short-term pain but Moya Greene, the chief executive, believes that in the long run operating costs in the UK will fall by “at least” 1pc this year, and probably a little bit better.
Royal Mail is a people business and its almost 140,000 staff contribute 68pc of the costs.
The company will further modernise with new automated parcel-sorting equipment being installed at a site in Swindon next month. The underlying operating profit margin has improved to 5.6pc.
Union support
The other big worry at the time of the flotation was that the necessary job cuts would see the company descend into years of industrial strife, but this hasn’t happened.
In fact the Communications Workers Union (CWU) was largely supportive of progress, and said the results were a “very solid performance” that defied those who thought Royal Mail couldn’t change.
Parcels of pain
Increased competition from Amazon, which is also its biggest customer, and from smaller rivals have all pushed down prices.
Parcel volumes increased 4pc after Royal Mail won new clients, such as John Lewis and Waterstones, but revenue only edged ahead 1pc.
The long-term structural decline in letters continued, with volumes down 4pc, and revenue falling 3pc.
There is also a new cloud on the horizon as the postal service is under investigation by Ofcom, the regulator, over claims that it used its dominant market position to unfairly price out competitors. Ofcom is expected to complete the review and put into place a new system from next year.
That said, Royal Mail shares trading on a forward PE ratio of 12, and offering a dividend yield of about 4.8pc look like a good long-term bet.
The shares also no longer have the overhang that they did, after the Government exited its final 14pc stake last. The shares remain a good long-term hold.