Questor share tip: Royal Mail a long term hold

The national postal service maintains income attraction for the long term investor, says Questor.

Market estimates are for Royal Mail to make pre-tax profits of £631m for the year ended March 2014 on revenue of £9.64bn,
Market estimates are for Royal Mail to make pre-tax profits of £631m for the year ended March 2014 on revenue of £9.64bn, Credit: Photo: GETTY IMAGES

Royal Mail
565.5p-18.5
Questor says HOLD

Royal Mail (RMG) shares have had a strong start to life on the listed markets. The company has passed from public ownership to private hands and sauntered straight into the FTSE 100, while sidestepping the threat of costly industrial action last year.

But now that job cuts have been announced what are the long-term investment prospects?

The investment case for the nation’s postal service was always fairly simple. As a company, it has a monopoly on letter and parcel delivery in the UK, which gives it pricing power. In April 2012 the group was largely freed from revenue controls, allowing it steadily to increase the price of stamps.

Royal Mail has two main businesses, UK Parcel and International and Letters (UKPIL), responsible for 84pc of revenue and employing 150,000 people and General Logistics Systems (GLS) responsible for 16pc of revenue.

Letters are in long-term decline, but revenue from delivering them is more stable as stamp price increases offset the drop in volume.

Parcelforce, the Royal Mail’s branded parcel delivery company, is growing. Royal Mail controls more than half of the UK parcel delivery market. The rise and rise of internet shopping is boosting home delivery. The parcel operation increased revenue by 8pc in the nine months ended December, delivering more than 3 million parcels every day. However, this business faces stiff competition from the likes of DHL and Fedex.

GLS operates as a parcel delivery operation across Europe. Competition in this region is tough and profit margins slipped to 6.7pc from 8.2pc in the year ended March 31. The division generates 16pc, or £1.5bn, of group revenue. GLS reported a 6pc increase in revenue and 5pc increase in volumes in the nine months ended December.

Royal Mail is slimming down to face life as a private company; the 500-year old postal service announced 1,600 job cuts to management roles yesterday.

Royal Mail say they expect the job loss programme to cost them £100m, but this will result in overall restructuring costs for the full year rising to about £230m, up substantially from the previous estimate of £130m.

Market estimates are for Royal Mail to make pre-tax profits of £631m for the year ended March 2014 on revenue of £9.64bn, so the impact on profits is meaningful.

As Royal Mail rightly point out, this will eventually save them £50m a year in wages. However, it looks as though the benefits from lower wages will be wiped out by a sharp increase in pension costs. Royal Mail said the cost of servicing the pension fund is to increase by up to £80m a year.

In the aftermath of the flotation last October, shares in Royal Mail enjoyed a stratospheric rise - triggering a heated political debate about whether it has sold too cheaply. In mid-Janaury they reached a record high of 618. But since then they have drifted sideways. City analysts are split exactly down the middle with five saying buy, five advising sell the shares and six sitting on the fence.

Questor was an early supporter of the Royal Mail flotation. Back on September 27, we advised “Get in quick and buy Royal Mail” at 330p. The shares have since returned gains of more than 75pc. We still like the long-term strength of the business and the dividend income, with the shares offering a forecast yield of 4.1pc.

However, the shares now trade on 17 times current year earnings. So, if there is any room left on that fence then Questor will join the other analysts. For long-term income, Royal Mail remains a hold.