Festive season key for Royal Mail

Holiday trading is make or break after patchy first half
Thursday 24 Nov 2016 Author: William Cain

Half-year results at Royal Mail (RMG) were a little softer than expected but the UK’s market-leading mail service still looks like a winner to us.

Adjusted operating profit, a measure of Royal Mail’s underlying business profitability, fell 5% to £262m in the six months to 25 September as revenues declined in its higher margin though declining UK letters business.

Analysts have left earnings estimates unchanged because profitability at Royal Mail is typically higher over the busy Christmas mailing period.

Royal Mail should be able to deliver earnings per share (EPS) growth of 5% a year out to 31 March 2019, according to estimates by Investec analyst Sam Bland. Current estimates for the year ending March 2017 are for EPS of 39.8p, meaning shares in Royal Mail trade on a price-to-earnings ratio of 11.6. Dividends are estimated at 22.4p for a forecast dividend yield of 4.8%.

Provided these estimates prove accurate, Royal Mail looks like a bargain. But a weaker economic outlook in the UK means Allan Smylie, analyst at investment bank Davy, is not convinced.

Below expectations

‘Royal Mail has delivered first half results modestly below our expectations,’ wrote Smylie following the publication of results on 17 November.

‘Within the mix, UK parcels are tracking better, while letters are weaker on lower marketing mail volumes, reflecting the poorer macroeconomic backdrop. The company has increased its three-year cost avoidance target by a material £100m to £600m by 2017/2018. We do not expect this to fully flow through to earnings given the weakening UK economy.’

Earnings and the economy are not the only risks at Royal Mail. Negotiations over its defined benefit employee pension plan are ongoing and remain the biggest near-term headwind to the company’s prospects.

Maintaining current defined benefit pension scheme promises to employees is becoming more expensive because low interest rates mean pension plan assets generate lower investment returns.

That means more money must be set aside upfront to fund future pension payments.

According to estimates produced at the end of September 2016, Royal Mail and its employees would need to contribute £1.4bn annually to maintain the scheme versus around £500m currently.

Dividends paid to shareholders totalled £213m in 2016 and Royal Mail’s adjusted profit after tax was £420m. (WC)

 Royal Mail is a good business and assuming a sensible outcome to pension talks offers good value.

‹ Previous2016-11-24Next ›

Important information:

These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell Youinvest.

Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.

Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.

The Shares team

The value of your investments can go down as well as up and you may get back less than you originally invested. We don't offer advice, so it's important you understand the risks, if you're unsure please consult a suitably qualified financial adviser. Tax treatment depends on your individual circumstances and rules may change. Past performance is not a guide to future performance and some investments need to be held for the long term.