Why City experts think Royal Mail shares are now a ‘sell’

Potential labour shortages and wage inflation ahead of Royal Mail's peak season are a key concern for some investors. This one has changed his mind on the postal giant.

Fears over the impact of UK labour shortages bit into the Royal Mail (LSE:RMG) recovery today when a City bank downgraded its view to “sell”, sending the FTSE 100-listed shares down 7%.

UBS's more conservative view on prospects for the letters and parcels giant includes a much-reduced price target of 440p, compared with 590p in its previous “buy” note.

The bank said today: “We expect increasing operational expenditure cost pressures are coming at a time when the pricing power within the industry is likely to decline as more parcel sortation capacity is added in 2022.”

In the current environment of wage inflation pressures, it says the Communication Workers Union (CWU) now has a high degree of bargaining power in multi-year pay negotiations.

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UBS's concerns about potential labour shortages and wage inflation ahead of Royal Mail's peak season have been fuelled by a look at the official statistics on UK transport job advertisements and recent salary increases for Royal Mail temporary workers.

It has downgraded its adjusted earnings estimates for 2022/23 by 8% and 15% respectively, meaning the latter figure is now 14% below the City's consensus.

Royal Mail's trading update last week highlighted “some anticipated upward pressure on costs,” but that profits and margins were still expected to be higher in the second half of the year.

The company also took into account the likelihood that its performance in parcels will start to normalise after the extremely strong trading during the pandemic.

Chairman Keith Williams told investors, however, that Royal Mail is increasingly confident that domestic parcels will re-base at a “significantly higher level” than pre-Covid and that the company can maintain its share of the market.

Despite this optimism, shares are 11% lower over the past week as UBS's downgrade from “buy” to “sell” sent the stock down 34.8p to 444p today. Other analysts are more positive, with Peel Hunt reiterating its support and a price target of 625p.

However, they added on Friday: “We are wary that a shortage of drivers and labour in parts of the UK, and a determination to recover Covid-impacted service levels, do not make for an easy environment to implement planned cost savings.”

Peel Hunt cut its profit forecast by 12% and lowered its target price from 680p but continues to have a “buy” recommendation.

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Shares topped 600p in June, up from 341p at the start of the year after prospects were boosted by rapidly accelerating e-commerce trends and modernisation progress on the back of a framework agreement with the CWU.

In other broker comment today, shares in British Airways owner International Airlines Group rose another 1% today after Deutsche Bank upgraded its target price by 15.6% to 260p.

Analyst Jaime Rowbotham said: “With the shares trading at 182p at yesterday’s close and with the US set to ease its entry requirements in early November, we think there is a much better backdrop for the shares to kick on from here.”