Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Festive season key for Royal Mail
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.
‘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.