HSBC puts £7bn valuation on Royal Mail

[POSTMAN]

http://www.theguardian.com/business/mar ... c-positive" onclick="window.open(this.href);return false;



Royal Mail rises as HSBC puts £7bn valuation on the business

Analysts point to strong cashflow and dividend hopes, despite growing competition

Royal Mail is in demand after a positive note from HSBC.

The bank has begun coverage of the postal service with an overweight rating and 710p price target, valuing the business at more than £7bn. There was of course, some controversy over the valuation of the company when the government sold shares last October at 330p, with claims the price was set too cheaply.

This latest optimism from the City has seen the shares add 3.5p to 578.5p. The HSBC analysts said:


The Royal Mail Group has come a long way in terms of its modernisation programme. Most of the big step changes have been made but ongoing investment in improving IT and potential investment in new parcels sorting equipment as well as productivity improvements should help the company to stave off cost base inflation. Mail volumes are declining 4-6% per annum but pricing flexibility alongside decent parcels growth of around 5% in 2015-16 is able to compensate for this. This means Royal Mail can still deliver revenue growth of around 2% per annum.

Modernisation costs are declining and with the legacy pension deficit offloaded, Royal Mail is generating substantial cashflow. It has committed to paying a £200m annualised dividend for 2014 which represents a 3.4% yield. But with a free cash flow yield of 6% in 2014, rising to 7.2% in 2015 this is around twice covered and there is significant scope for increase. The balance sheet is not highly leveraged and upside could come from property disposals.

End-to-end competition is a potential threat: TNT Post UK, which accounts for 20% of volumes for the Royal Mail, is gradually rolling out an end-to-end network. We believe that TNT's current end-to-end ambitions extend to around 6% of Royal Mail's volumes but in response Royal Mail has changed its access pricing to try to thwart cherry picking of the more densely populated areas. TNT has lodged a complaint and Ofcom is investigating. It remains unclear how Ofcom will deal with this and what action it will take if end-to-end competition does hurt the profitability of the Royal Mail.

We see the strong cash flow generation as the key attraction of the Royal Mail and added to this potential upside from property disposals. Aside from the emergence of end-to-end competition, the key downside risk is higher-than-expected mail declines, as in the short term the cost base is sticky.