Interactive Investor

Royal Mail: a new name as white-knuckle ride continues in Q1

20th July 2022 07:38

Richard Hunter from interactive investor

Life as a listed company can be a bit of a rollercoaster ride, as the country's favourite postie has found out. It's just had a good week, but the latest update is a frank assessment of its position. Will a change of name improve prospects?

In its own words, Royal Mail (LSE:RMG) is at a crossroads, with recent progress having stalled and a weaker outlook in prospect.

In a particularly frank statement, the group has listed the challenges currently being faced. A recurring theme is the likelihood of industrial action, which will further hamper progress on its much-needed transformation programme. At the same time, the burgeoning parcels market has stalled, with inflationary pressures leading to less retail spending and therefore deliveries.

Indeed, Royal Mail describes the pandemic boom which resulted in higher parcel volumes and the delivery of test kits as “over”. In addition, the terminal decline of the letters market has resumed, putting more emphasis on the parcel businesses in what is an increasingly competitive market.

Amid the lower volumes, where revenue at Royal Mail fell by 11.5% in the first quarter of its financial year, an inflexible cost base in terms of overtime and temporary resources has led to an adjusted operating loss of £92 million, or around £1 million per day as highlighted by the company. The outlook is that Royal Mail should now break even in the year to March 2023, although that projection excludes the impact of any industrial action.

The GLS business on the other hand continues to do most of the heavy lifting. Despite a drop of 3% in volumes during the three months to June, revenues rose by 7.8% driven by higher freight revenue and stronger pricing. The operating profit of £94 million leaves the full-year target of between €370 million to €410 million intact, which should be achievable even given some margin compression arising from higher costs.

The frustration of the current situation is clear to see from the group’s comments, but some elements of optimism remain. The previous investment in efficiency has already led to higher automation, the strength of the group’s resources leave it stable and well-positioned, while the continued contribution of the GLS business flatters the overall figures. The current dividend yield of around 7% is particularly punchy, even though it is of little solace to long-suffering shareholders in terms of total return.

Why the new name?

In order to recognise the two very separate arms of the business, the holding company is to be renamed “International Distributions Services”, which reflects the desire of the board to move away from one unit cross-subsidising the other and for these to remain discrete.

Indeed, the comments suggest that even a separation of the businesses at some stage could be on the table, which would be an interesting step indeed to unlock the value of the GLS unit, while leaving Royal Mail to fend for itself.

All things considered, the white-knuckle ride for shareholders is likely to continue.

Even prior to today’s update and the subsequent 5% drop in price during early deals Wednesday, the shares had lost 46% over the last year, as compared to a decline of 13% for the wider FTSE250 index. The price is now 14% below the initial IPO price when the company floated in 2013, and 55% below the peak price of 630p achieved in April 2020.

Market consensus has unsurprisingly weakened against the current backdrop, yet on balance the ability of an unfettered company to drive further progress is also recognised, even though it is unclear when the group will be free to continue on its journey. As such, the view of the shares as a "cautious buy" could come under further negative pressure.

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