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Shares in the UK postal operator Royal Mail (LSE: RMG) have hammered the FTSE 100 so far this year, climbing 28% during a period when the big-cap index has fallen by 3%.
Of course, such short-term movements aren’t especially significant. Looked at over the 3.5 years since the postal group’s flotation in 2013, both investments are up by around 10%. Despite this, I believe this 500-year old firm is in a good position to face the future and deserves closer attention from investors.
I’ll come back to this in a moment, but first I want to look at a faster-growing alternative investment in the same sector.
A modern business
One of the challenges faced by Royal Mail has been to adapt to a huge increase in parcel volumes from internet shopping.
One company that’s benefited from this change is Leeds-based Clipper Logistics (LSE: CLG). This £441m firm provides logistics services to the retail sector, specialising in e-commerce. Existing customers include ASOS, Sainsbury’s, John Lewis and Superdry.
Clipper shares edged higher today after the firm announced a new contract to run a 600,000 square feet warehouse for Boohoo.com subsidiary PrettyLittleThing.com. This brand is a big player in the youth fashion market and is growing fast — sales rose by 228% to £181.3m last year.
Clipper will handle goods from a range of suppliers and provide fulfilment services for online orders. It’s a big win for the firm and will require 1,200 new staff, increasing existing headcount by more than 25%.
A smooth delivery
Clipper already has a strong track record of growth. Revenue has grown by an average of 15% per year since 2012, while operating profit has risen at a compound average rate of almost 22% each year.
The group’s operating profit margin of about 5% is good for this sector. And last year’s return on capital employed of 34% suggests to me that this is a very well-managed business, as it implies that the company made £34 of operating profit for each £1 invested in its operations.
An increasing level of scale and automation is required to compete in retail logistics. I think Clipper’s growth is likely to continue — a view shared by City analysts who expect the group’s earnings to rise by almost 25% this year.
Although the stock looks pricey on 28 times forecast earnings, this multiple could soon fall. I’d continue to hold and would buy on any short-term dips.
Why I’d still buy Royal Mail
The shares aren’t quite the bargain they were towards the end of last year, but I believe Royal Mail still offers good value for investors looking for reliable long-term income growth.
Chief executive Moya Greene surprised markets recently when she announced plans to leave. But Ms Greene’s time in charge has been well spent. She’s managed a successful privatisation and strengthened the group’s finances. She’s also reached new deals on pay and pensions with unions, increased automation, reduced headcount, and positioned the group for a parcel-led future.
Analysts expect earnings to be broadly flat over the next year or so, suggesting that the forecast P/E of 14 may be high enough. That may be true for now, but I feel Royal Mail’s strong free cash flow and 4.1% yield mean that the shares are still worth buying.