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The letter is dead long live Royal Mail

Royal Mail’s bread and butter business is in structural decline.  As sure as video killed the radio star email has killed the letter.  Following the accession of a new monarch in various countries on lookers would proclaim ” the king is dead, long live the king “.  As one monarch dies they salute the new monarch.  Royal Mail’s letter business is dying but they are saluting new avenues of growth from Parcel Deliveries in the UK and around the world through the wholly owned dutch subsidiary General Logistics Systems (GLS).

Let’s take a look at why Royal Mail could be a good investment.  Royal Mail was fully privatised for the first time in 500 years in October 2013.   During is life as a state run monopoly Royal Mail built up a massive asset base and had no pressures regarding operating efficiency (like modern publicly listed companies do).  It employees are well treated with generous pensions and sorting offices use aging technology.  For the new management of Royal Mail cost saving opportunities will be around every corner.  From making better use of technology to bringing the employee pension scheme up to modern standards.

Modern technologies are being employed to create productivity gains, the work force has been reduced and the number of mail centres and delivery offices have been reduced.   Rivals like Deutsche Post (DP) where privatised years ago and it has had a marked positive affect on their business (possibly not for employers but for the business).  DP sports operating margins of close to 8%.  Royal Mail’s operating margins are just over half of that figures so they’ve got some catching up to do.  Catching up is what they are currently doing.

What has an investment in Royal Mail share got going for it?

  • Lots of low hanging fruit for saving costs, costing savings plan increased to £600M by 2018.
  • Can bid for contracts outside of the UK allowing Royal Mail to benefit from Globalisation. GLS operating in 42 European Countries and all over the world and is the 3rd largest parcel delivery provider in Europe. Revenues from this part of the business are growing at nearly 10% per year.  Stimulation of Eurozone economies by the European central bank are feeding through to GLS’ main markets including Germany, Italy and France.
  • Operating profit margins and operating profits should rebound as transformation costs reduce and investments in acquisitions start to enhance earnings. Geographic expansion has been made having purchased ASM in Spain and GSO in California, USA.
  • More control over pricing in the UK and in the other countries they operate in.
  • Online shopping is growing at 10% per year.  Parcel Deliveries are becoming a larger part of the delivery Market help offset the decline in letter deliveries.  Royal Mail should continue to win a significant part of this business despite competition from TNT, DP and Yodel.
  • Offering customers a better service.  Personally having bough myself a new watch recently with Royal Mail’s 24/7 tracked service I new where it was each step of the way.
  • Royal Mail owns lots of property.  As property prices have inflated the value of not or under used Royal Mail property has soared.  Sale of these assets to property developers desperate for quality plots in prime London locations will help fund Royal Mail future expansion plans and pay it’s dividend. Owning property is also a good hedge against inflation.
  • Royal Mail debt is relatively low.  Interest payments are covered by operating earning easily and net debt is a comfortable amount.
  • Dividend growth was over 5% last year and is expected to be over 4% this year.  The dividend yield is currently higher than average.
  • As far as the share is concerned it is in a range bound market and currently sits at the bottom of the range.  Making a increase to the upper end of the range a good bet.

What are the negative aspect of investing in Royal Mail

  • Higher transformation costs and investment spend has hit operating profits and reduced profit margins
  • The dividend is barely met by free cash flow after capital expenditure, financing and acquisition costs. Albeit higher due to the current transformation and acquisitions to lay down geographical expansion.
  • Amazon are delivering their own parcels.
  • Increased competition from Rivals, espcially in the UK market.  For instance Deutsche post has moved into the UK market by buying UK Mail.
  • Regulatory burdens reducing competitiveness, such as having to provide the universal service
  • Slightly overvalued compared to the transportation industry average (not taking into account dividend growth)

Big questions remain

Can the growth in Global operations and high performance of UK Parcel deliveries offset the reduction in revenue from UK letter deliveries?

Can acquisitions add to growth after financing costs?

Will the cost reduction programme go to plan without spiraling transformation costs?

Will dividend increases continue at the current rate?

Opinion of the author; Royal Mail is a good bet based on dividend yield, dividend growth rate, manageable debt levels, transformation plan of decreased costs, technological enhancement and productivity drive going to plan, and the global expansion.  A reduction in operating costs will see it’s share price move up and reduce it’s PE ratio to be inline with that of Deutsche Post, which has a 5 year average PE of around 15 and a lower dividend yield.

 

Disclosure; the author owns share in Royal Mail. 

 

 

 

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