Royal Mail - Whistl while you work

Royal Mail Group: After the Christmas demise of City Link, there must have been a further modest whooping when Whistl suspended (forever?) its delivery service recently. However, that was only one of the varied challenges facing Royal Mail. In the internet age, parcel delivery should be a growth industry, but it is economically sensitive. It is also very competitive, as shown by their major customer Amazon setting up their own delivery system and stalling Royal Mail’s parcel volume growth. (That is before we get onto the potential for drone delivery.) Meanwhile, Royal Mail’s Universal Service Obligation is a difficult cost to shift, but there are plenty of other costs to attack. However, with hundreds of years of heritage some of the organisational rigidity is pretty baked in, with a labour force that is still heavily unionised. So how have they done so far?

In these 52 week results (to 29^th March 2015), revenue nudged up 1%, whilst pre-tax profits rose to £569m from £421m. Operating profit was £595m (FY2014: £488m) after transformation costs of £145m (FY2014: £241m), with a 40bps improvement in operating profit margin. Eps came out at 42.8p (FY2014: 30.8p), on the back of which the dividend was raised 5% to 21p, from last year’s notional 20p. Free cash flow grew to £453m, helped by lucrative property disposals, helping to see net debt shrink from £555m to £275m. After some neat pension footwork at flotation, they can state that the IAS pension surplus (yup!) increased by £1.1bn to £3.2bn. Whilst they outline tough trading conditions and a reliance on Christmas trading, they are on track to meet forecasts so far this year, alongside a commitment to grow dividends.

The problem appears to be that improving the top line is challenging and cost cutting is a finite exercise. Yet the group has got good cash generating characteristics and huge strength as the incumbent, even if there are plenty of pea-shooters aimed at them. Before getting too gloomy, it is worth pointing out the example of the tobacco industry where dividend growth has been handsome, despite the vilification of the industry. Consensus forecasts seem to be for an eps fall next year, which seems harsh. If they match this year’s eps of 42.8p, then, at 500p, the PE is 11.7x. A dividend of, say, 22p would be a yield of 4.4%. These look attractive valuations to me, but after the run that the shares have had, perhaps there will be cheaper days to pick them up. (Neil Cumming^, 21^st May 2015)

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