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Should Investors Still Back Royal Mail?

27 Nov 2018, 23:36

http://www.morningstar.co.uk/uk/news/172155/should-investors-still-back-royal-mail.aspx/
Equity Research & Insights

Should Investors Still Back Royal Mail?

Royal Mail boss Rico Back went bargain hunting for shares last week after his firm's share price fell to an all-time low. We re-visit the investment case

David Brenchley

26 November, 2018 | 12:49AM

Royal Mail, Royal Mail share price, profit warning, FTSE 100


It wasn’t long ago we wrote positively about Royal Mail (RMG), with shares flying, promotion back into the FTSE 100 in the bag and fund managers backing the firm to continue trending upwards.

That was eight months ago. Shares had climbed over 50% since their November 2017 low point of 370p, and the value investors that had picked the stock up at such a depressed multiple thought there was plenty cash to be made.

In the short run, they were proved correct. Royal Mail continued its upwards trajectory to reach an all-time high 631p in May, 70% higher than six months earlier.
But that’s where things turned sour. Shares dipped 5% in the run up to full-year results, and fell a further 9% in the following days after a mixed bag of results with some numbers beating expectations and others, including profits down by 37%, disappointing.

A shock profits warning from new chief executive Rico Back early last month and a half-year update a fortnight ago sent shares into freefall. In the space of the seven weeks after the profit warning, the stock plunged by over a third to trade below its October 2013 flotation price.

Now, the bargain hunters are back in town, potentially buoyed by the slight uptick in the interim dividend to 8p. The full-year payout for 2019 is expected to be broadly unchanged at 24p, giving a yield of 7%.

One of those bargain hunters is Back, who snapped up £500,000 worth of shares last week. A relief rally has ensued in the past seven days, with the stock up 11% at 343p today.

Royal Mail: The Analyst View

The view on the stock has not really changed. Broker Cantor Fitzgerald Europe has always had a ‘hold’ recommendation for clients. After half-year results, though, it did slash its target price by 30% to 350p.

UBS also cut the target price, by a third to 354p over 12 months, but it kept its ‘neutral’ view.

With earnings per share forecast to come in at 27p-29p for 2019, the stock trades currently at around 12 times forward earnings, pretty much in-line with the wider UK logistics sector at 12.5 times and at a slight premium to the European postal sector at 11 times.

“The attractive dividend yield probably sets a floor for the stock at current levels, but we see no compelling ‘buy’ case pending the strategy update,” says Robin Byde, research analyst at Cantor.

The worry, explains Byde, is the impact the continued rapid decline of its UK letters business has on future margins and free cash. This could have big implications for the sustainability of the dividend. That’s not to mention the pension deficit, which, at £400 million a year, is the largest of any UK company.

“For the new management, the task is still a tough one and the industry continues to face many challenges,” adds Helal Miah, investment research analyst at The Share Centre. "Competition within the delivery business is getting ever more intense, while Royal Mail, unlike its rivals, will still be distracted by having to deliver letters even though this is a slowly dwindling market.”

For now, caution is urged, with analysts and investors alike turning their attentions to the January trading update, before a ‘pivotal’ capital markets day slated for March, where an update on Back’s new five-year plan will be eagerly anticipated.

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