Interactive Investor

Royal Mail shares: should you keeping buying after 225% surge?

20th January 2021 14:04

Graeme Evans from interactive investor

Shares in the nation’s postie have rocketed since last April. Here’s what a top City analyst thinks of them.

A “seismic shift” on Royal Mail (LSE:RMG) shares today saw a City bank boost its price target by 72% and forecast the parcel company's best earnings since it joined the stock market in 2013.

Deutsche Bank's bullish note reflects rapidly accelerating e-commerce trends as well as modernisation progress after bosses struck a framework agreement with the CWU.

To add to the growing optimism for Royal Mail's army of retail investors, Deutsche thinks that a very modest dividend of 2p a share, and worth £20 million overall, is on the cards with 2020/21 results. This translates to a 0.5% yield but would still send a positive signal on the turnaround.

Shares have rocketed 76% since the start of November and by 225% since last April. Today they were trading above the 400p level for the first time in more than two years. The rise reflects City expectations that next month's trading update from Royal Mail will reveal another big jump in parcels revenues over Christmas and into January, as restrictions continue to stop people visiting shops.

 These structural changes caused by the Covid-19 pandemic mean Deutsche Bank analysts have materially rebased their forecasts, with earnings per share for 2021 raised 28% to 31.7p. 

They have also increased by 45% their 2022 forecast to 50.2p a share. This figure is 78% higher than the current City consensus and, according to Deutsche, would be the best result since the company floated on the stock market in 2013.

On the back of its new estimates, Deutsche has lifted its target share price from 320p to 550p and raised its recommendation to ‘buy’ to reflect a “seismic shift” in the outlook.

The bank previously had a ‘sell’ rating between December 2017 and May last year, a period when the shares fell 63% and underperformed the FTSE 100 index by 43%.

Removing Deutsche's more recent ‘hold’ rating, analyst Andy Chu said the group now looked capable of growing its earnings over the medium term.

He added: “Although Royal Mail is still in transformation and modernisation mode, the company is in a much better position to negotiate with the CWU and to generate sufficient free cash flow to restart modest amounts of dividend payment.”

Sentiment was given a major boost three days before Christmas when Royal Mail reported strong parcels growth in October and November, and said it had reached agreement with union leaders on pay and a future direction for the business.

This involved a 2.7% pay increase effective from last April and a further 1% pay rise from April 2021. The company is currently working with the CWU on the details of the agreement, including ways to achieve more efficient working practices.

The shares had been as low as 124p in April, dealing a fresh blow to retail investors who received 227 shares from the heavily oversubscribed flotation at a price of 330p. The stock is still one of the most widely held companies on the London market, including among many of the 140,000 postal workers who were given free shares.

The faster-than-expected growth of business-to-consumer parcel operations has transformed fortunes in recent months and offset the decline in the traditional letters market.

These favourable trends were also highlighted today when supply chain business Wincanton (LSE:WIN) issued profits guidance materially ahead of current City forecasts.

The biggest benefit has been in the digital and e-fulfilment sector where revenues were 40% higher in the most recent quarter as people continue to shop from home. Further significant contract wins with Waitrose and Dobbies are expected to start in the 2020/21 financial year.

Shares jumped 13% or 36p to 308p, the highest level for the company since January.

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