The future for Royal Mail shares

There's a big dividend yield, but growth is unimpressive. Here's the latest thinking on shares in the nation's best-known postie.

Royal Mail (LSE:RMG) shareholders who chose not to sell when shares hit 600p last summer had reason to rue their decision today as a City firm downgraded its target price by a third to 280p.

UBS’s removal of its “buy” recommendation meant another poor session of trading for the parcels and letters delivery firm, which is now at its lowest level since November 2020 at 265.9p and no longer a member of the FTSE 100 index.

The widely held stock had been one of the best performers during the pandemic, but its valuation has slumped since last June’s peak for reasons including the worsening consumer spending outlook and fears over industrial action.

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UBS today cut its earnings per share forecasts for the next two years by up to 24% and warned of further downside if the Communications’ Workers Union (CWU) proceeds with strikes.

The bank said: “In a deteriorating economic background we revise down our volume assumptions for UK parcels.

“We also take a more cautious view in terms of self-help potential on cost cutting and market share gains to reflect the deteriorating relationship with the unions.

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UBS’s more conservative view on online shopping trends means it now thinks Royal Mail will give back around one-third of the parcels volume growth seen during Covid, equivalent to a UK fall of about 6% year-on-year in 2022/23.

It forecasts a financial hit to underlying earnings of between £50 million and £100 million for 1-2 days’ of strike action, equivalent to up to 17% of last year’s total reported figure.

The CWU recently announced its intention to ballot for a strike, with the earliest possible date for action being August. Every 1% of pay equates to about £45 million of cost inflation, highlighting the importance of the current negotiations to Royal Mail.

It added in May: “We want to reach an agreement with CWU, but industrial action, or the threat of it, is damaging for our business and undermines the trust of our customers.

“It also makes delivery of our change programme more difficult and puts at risk our targets for 2022-23.”

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As well as customers switching away, UBS highlighted the incremental costs associated with hiring temporary workers to clear a subsequent delivery backlog. This is partly offset by savings on wages as employees are not paid during strike days.

It also assumes between £100 million and £125 million of £350 million cost cutting targets are linked to the relationship with the union and may not materialise in full this year.

Royal Mail shareholders are due to gather for the company’s AGM on 20 July, when they will get an update on current trading. In the annual report published on Friday, chairman Keith Williams highlighted “significant headwinds” at the start of the 2022/23 year and said it was “more important than ever that we accelerate the transformation of Royal Mail”.

Royal Mail recently returned £400 million of surplus cash to shareholders through the payment of a special dividend in January and a buyback programme completed in March. On 6 September, it is due to pay a final dividend of 13.3p in relation to 2021/22 trading.