Royal Mail - Europe remains a bright spot

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Royal Mail has this morning released a trading update for the three months to 26 June 2016. Trading for the period was in line with expectations, with Group revenue increasing 1%. Royal Mail shares were broadly flat in early trading.

The UK business (UKPIL) saw revenues decline by 1%, as a 2% increase in both parcel volumes and revenues was outweighed by a 2% decline in addressed letter volumes and 3% decline in letter revenues.

Excluding one-off benefits from mailings associated with the EU referendum and timing of direct delivery returns from the prior period, UK addressed letter volumes declined by around 4%.

UK letters continued to see declines among higher margin consumer/SME customers, although parcels saw trends improving in this segment. Parcels also enjoyed uptrading among Royal Mail account parcels customers to the tracked service.

The European parcels business (GLS) delivered 13% growth in both volumes and revenues, achieving revenue growth across all markets. The division benefited from the timing of Easter and other public holidays across Europe - which accounts for around 4 percentage points of volume and revenue movement.

Commenting on the outlook for the business Royal Mail noted that demand for its letter and B2B parcels services are driven by movements in GDP - which it is monitoring. The group remains focussed on operational and financial efficiency.

Recent Developments

The group agreed a 1.6% pay award with the Communications Workers Union (CWU) for 2016-2017, with Unite pay awards for junior and middle managers in Royal Mail of 1.6% from September 2015 and 1.3% from September 2016.

During the quarter the group acquired the Spanish express parcels business, ASM Transporte Urgente, for EUR71m, and same day delivery company eCourier in the UK.

Our View

We have come to expect solid, if uninspiring results from Royal Mail - with perhaps a touch of glamour from double digit European growth. The UK business remains sluggish, without the benefit of the EU referendum the decline in letters volumes would be in line with company estimates, with competitive pressures in the UK parcels business showing no signs of easing.

UK parcels was supposed to be the growth engine for Royal Mail, with the UK letters business in decline. So it is somewhat concerning that conditions in the UK parcel market look set to remain challenging. The demise of rival City Link in December 2014 has been followed by a host of announcements from other parcel operators warning of pricing pressures. Amazon choosing to launch its own delivery network compounds the issue. Overall, Royal Mail estimates that there is around 20% annual spare capacity in the market.

Royal Mail is in a much better position than other postal operators to weather the storm, we feel. It is by far the largest player, with around 50% of the UK parcel market, so can invest more in technology and service. There is plenty of scope to reduce costs, having spent so long in public hands. This should help to support profits, at a time when rivals are seeing margins squeezed.

We think Royal Mail is performing well in a tough environment. The UK parcels business isn't growing much, but nor is it in decline; while costs are being very tightly managed. The group generates good cash flows and has a healthy balance sheet, underpinned by a substantial London property portfolio. Although a significant pension deficit is a potential concern, for now the prospective yield of 4.6% looks well underpinned - although remember all yields are variable and not guaranteed.

All yield figures are variable and not guaranteed. The information in this article is not intended to be advice or a recommendation to buy, sell or hold any investment mentioned, nor is it a research recommendation. No view is given as to the present or future value or price of any investment, and investors should form their own view in relation to any proposed investment.