Interactive Investor

Royal Mail thrives during pandemic parcels boom

20th May 2021 08:09

Richard Hunter from interactive investor

Royal Mail has been saved by the pandemic and promises a generous dividend, but can the resurgence last?

Pressures arising from the pandemic have given Royal Mail (LSE:RMG) the jolt it needed and with startling effect.

The spike in volumes during the pandemic accelerated the trend away from letters and towards parcels at a pace which forced the transformation of the company at lightning speed. Indeed, the company describes the situation as having given it “breathing space”, and the scene is now set for the next raft of challenges. This will include the level to which the change in the business mix will stick in a post-pandemic world.

Parcel revenues now account for over 70% of the group total, underpinned by a burgeoning General Logistics Systems (GLS) international business which is a clear engine of growth. The operating margin at GLS improved significantly to 8.9% over the period (as did the group figure to 5.6% from a previous 3%), with revenues overall up 28%. The growth has continued into April after the end of this reporting period, with revenues up by 22.3% year on year.

At the same time, Royal Mail also reaped the rewards of the intensified pressure, with parcel revenues up by 39% despite the headwinds of a decline of 12.5% in letter revenues and an increase of 9% in operating costs. This led to an increase in revenues of 12%. In April, revenues were also up by 24%.

Overall, the group achieved its guided adjusted operating profit, coming in at £702 million, which compares to £325 million the previous year and pre-tax profits of £726 million versus £180 million. Net debt also sharply reduced from £1.1 billion to £457 million, all of which enabled the return to a payment of a dividend. Based on the new policy to pay a sustainable dividend, the implied yield of 4% is attractive against the current interest rate backdrop for income-seekers.

From here, Royal Mail is aware of the challenges which remain. The group will need to be alert to a particularly fierce level of competition in the parcels business, while it remains unclear how sustainable the current volumes are as customers have been driven to online shopping from their homes during the pandemic. At the same time, the effect on business volumes after the return to some kind of normality is also difficult to gauge, while hefty ongoing investment will be required to maintain progress so far.  

The share price performance has been a white-knuckle ride for investors. From an initial float price of 330p in 2013, the shares peaked at 630p in May 2018 and then troughed at 124p in April 2020. Over the last year, the shares have risen by 204% to the current level of around 530p. The wider FTSE 250 index is up a comparatively modest  36%. 

Such has been the strength of the rise that Royal Mail has become a strong contender to regain its FTSE 100 status at the imminent June reshuffle, having lost its place at the top table in December 2018. With the enforced transformation programme having been a success, and with the level of growth at GLS continuing to propel prospects, investors have been willing to back the company, as evidenced by the recent elevation of the market consensus to a 'strong buy'.

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