Royal Mail warned of earnings risk

[TrueBlueTerrier]

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Risks are building for Royal Mail (RMG) this year. Competition is becoming even more intense, the free cash flow story is deteriorating, and political risk is likely to grow in the run up to the general election in May.

It's why Credit Suisse has cut its target price and is left bemused as to why, after a sharp cut in consensus earnings per share (EPS) estimates, the stock has re-rated sharply this year.

Credit Suisse warned in November that 2016 consensus estimates had to 'shift down'. They have. Since January EPS forecasts have fallen by about 9 per cent. Royal Mail shares, however, have re-rated by about 8 per cent on a price/earnings (p/e) basis.

'We think this is unjustified and see further negative earnings momentum to follow,' says the broker. 'We now sit 24 per cent below 2016E EPS consensus and we see risks building into calendar year 2015.'

CHALLENGE

Its part of Dutch mail giant PostNL, formerly Post UK, looks close to completing its joint venture with Lloyds Banking Group's private equity arm LDC, says Credit Suisse, providing funds for a resumption of its UK rollout and serious competition for Royal Mail.

Meanwhile, the free cash flow yield has fallen from a peak of 9.4 per cent in 2014 to an estimated 6.7 per cent in 2016 'representing a fundamentally less attractive offer. Scope for further transformation (£100 million) and cash pension costs (£50 million) in 2016E would reduce that to 3.2 per cent'.

What's more, political risk clearly grows as the election nears, and while property disposals may provide some respite, Credit Suisse thinks incremental cash returns to shareholders are unlikely.

The broker cuts underlying EPS forecasts again, this time by 3 per cent for 2016 and 12 per cent for 2017, driven by currency adjustments for a weaker euro impacting Royal Mail's European parcel delivery business GLS, the impact of German minimum wage adjustments on margins, price cuts, plus a weaker mail pricing model for 2017.

'High operational gearing in UKPIL [UK Parcels, International and Letters] highlights the challenge RMG faces from small changes to its top line,' says Credit Suisse. 'We cut our target price by c.3 per cent to 370p and remain underperform.'

At 427p, Royal Mail trades on an adjusted 2016 p/e of 17.5 times for 6.7 per cent free cash flow yield and 4.9 per cent dividend yield. That compares with peers at 17.4 times, 5.4 per cent and 4.2 per cent, respectively.

[Jamesneil2014]

Our shares will be worthless soon!.

[houseoflords]

The money men have made their money now its just the dregs left