HSBC cuts price target for Royal Mail on pension concerns

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The projected dividend yield of 5.3% is getting up there with sector peers Austrian Post (6.1%) and bpost (5.8%), and HSBC believes Royal Mail has better growth prospects than either of those

Banking giant HSBC has reduced its price target for parcels and letters delivery group Royal Mail Group PLC (LON:RMG), reflecting two major uncertainties.

The first of those uncertainties is the short-term trading outlook, which is looking bleaker than ever given fragile UK business confidence.

The second is the well-publicised pension-related difficulties, with the cost-cutting management keen to close its main defined benefit pension scheme.

HSBC trimmed its earnings per share (EPS) estimate for the current financial year by 2.3% from 41.3p to 40.3p to reflect the cloudy trading outlook.

Its discounted cash flow-derived target price drops by 14% from 513p to 443p to account for what HSBC calls “the vagaries of the current pension negotiations”.

With the shares trading at 407p, you might think that would make Royal Mail’s shares a ‘buy’, but HSBC sticks with its ‘hold’ rating.

“It is difficult to make a compelling investment case for Royal Mail, in our view; however, we acknowledge that the group offers reasonably attractive prospects for long-term growth, in the context of the postal industry,” HSBC conceded.

“This is centred on: a credible presence in the Europe parcels market; an enhanced IT capability, which should underpin an improvement in the customer service offering; a focus on growth investment and a healthy cash flow supporting an estimated 5% dividend CAGR [compounded annualised growth rate] for the coming three years and leaving sufficient free cash available to support future bolt-on acquisitions,” HSBC continued.

The recent third quarter trading statement did little to lift the gloom, the bank asserted.

There was an appreciable deterioration in letter volume trends in the fiscal third quarter, albeit against some tough comparative figures from the previous year, though parcels performance in the UK and Europe remained resilient.

Meanwhile, pension negotiations drag on.

“The ultimate cost of the new arrangements is not yet known and unions have reserved the right to ballot for strike action. Such action could prove damaging to the long-term prospects of the business as it could drive customers away permanently. It is unlikely in our view that the shape of any future settlement will be known much before the second half of the calendar year,” HSBC speculated.

The good news is that the projected dividend yield of 5.3% is getting up there with sector peers Austrian Post (6.1%) and bpost (5.8%), and it is possible this will provide a floor for the share price.

In HSBC’s view Royal Mail has better growth prospects than both.