Interactive Investor

Royal Mail shares dumped to 14-month low after downgrade

2nd March 2022 15:14

Graeme Evans from interactive investor

A star of the pandemic, shares in the nation’s favourite postie have been hit again following fresh research from a City analyst. There’s a new price target too.

A Royal Mail (LSE:RMG) “sell” recommendation heaped more pressure on shares today as City attention turns to how margins will cope with potential big pay rises for frontline postal workers.

The widely held stock was one of the best performers during the pandemic, but inflation concerns and service issues in some parts of the country have contributed to a reversal from 600p in June to 363.2p, including today's fall of 24.5p.

The margin worries were highlighted by Liberum analyst Gerald Khoo as he cut his earnings forecasts for next year and 2024, while also reducing his price target from 470p to 355p.

His downgrade from “hold” to “sell” comes as the Communication Workers Union (CWU) begins its annual round of pay negotiations with management.

The CWU has not disclosed the figure requested, but Khoo references a video to members pointing out that the union is looking for a pay rise to match inflation without strings attached on productivity or other factors.

Compromise is inevitable in the coming weeks, but Khoo sees the risk of a margins squeeze if a pay deal is achieved anywhere close to the current level of the retail price index at 7.8%.

He believes that price increases or productivity improvements will be insufficient to offset the UK wage inflation pressures. Around 67% of Royal Mail’s UK operating cost base is accounted for by people costs, including pension costs and National Insurance.

Liberum also estimates that a 1% increase in wages raises total costs by about £45 million, or around 6% of its 2022 profits forecast for the group.

Khoo said: “Even linking a pay hike to productivity might not be enough to defend margins, with a 3% improvement being the best the UK business has achieved.”

He added that price rises for 2022 were implemented in January and the competitive market place for parcels limits the company's ability to offset inflation. Khoo said: “Its monopoly in letters gives Royal Mail more pricing power but set against this is the risk of an adverse volume reaction that could accelerate the rate of structural decline.”

Other brokers have been more optimistic, with JP Morgan Cazenove having a price target of 708p as recently as late January.

That price target was issued followed Royal Mail's third-quarter update, which showed continuing favourable trends from the structural shift in parcel volumes since the start of the pandemic.

However, the company also said that services had been affected in some parts of the country due to around 15,000 staff being off sick or isolating in early January due to the Omicron variant.

Tackling these pressures has already resulted in £340 million being spent in the year to date on overtime, additional temporary staffing and sick pay, as well as providing targeted support for the offices most impacted. 

It added in January that it had started a consultation on a management reorganisation aimed at generating annual savings of £40 million. 

Chairman Keith Williams said the past few months had demonstrated ongoing challenges around improving both quality and efficiency.

He said: “Looking forwards, the delivery of our transformation and modernisation plans remain incredibly important in light of the fast-paced change we are seeing and ongoing inflationary pressures.”

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