Royal Mail is one of the biggest share success stories of the year, having posted a 25% price rise since listing at 330p in mid-October.
With its maiden results providing further support for the bull case, could the postal service represent the next big dividend play in your clients’ portfolios?
Much depends on whether you believe the transformation programme that is currently being undertaken will prove successful.
The company’s first set of half-year results since the government floated its 60% stake suggest things are moving in the right direction. Revenue rose by 2% to £4.5 billion over the six months to the end of September, while operating profit rose to £283 million, up from £144 million in 2012.
Margins improved like-for-like to 5.2% from 3.3%, earnings before interest, taxes, depreciation and amortisation was up by £79 million to £483 million, while the business reaped the benefits of lower than expected transformation costs. Profits were boosted by a one-time, non-cash benefit of £1.35 billion as a result of pensions reform.
‘It is easy to make a bull case as the government is very bad at owning things and running businesses and every other privatisation has radically improved once the government is out of the picture,’ Mark Slater of Slater Investments commented.
He applied for shares at issue but did not receive any and has not been tempted into the stock since it floated. Nonetheless, he says it is one he will monitor
as he expects the management team could have further success in turning the business around.
‘Other quoted businesses of a similar nature in Europe have better margins so you can make the bull case,’ he added.
£133 million divi payout
One of the most interesting parts of Royal Mail’s results was its intention to pay a final dividend of £133 million next July.
This amount is approximately two-thirds of the notional full year dividend of £200 million that the directors would have proposed if the company had been listed throughout this financial year.
With underlying free cashflow at £103 million, down from £14 million the previous year and net debt down some £183 million to £723 million – could the stock become a bedrock for income investors?
Gervais Williams of Miton Asset Management says it could. He is positive on the management team’s prospects to turn the business around, opting to buy the stock straight after it floated across the funds he runs. These include the CF Miton UK Multi-Cap Income fund.
‘It does rely on being successful in implementing change, but I do think that at the moment the future looks pretty bright,’ he said.
Although letter volumes are down, he points out they are stabilising. With greater customer levels, he expects Royal Mail can increase market share.
‘They are in a strong position to take advantage of a very comprehensive network of opportunities to deliver across the country in a competitive way,’ he added. This gives Royal Mail a significant advantage against its competitors, he believes.
Others are less enthused, however, arguing the underlying dynamics of the industry remain challenging, these include David Ridland, an investment manager and founder of Castlebay Investment Partners. The boutique uses a proprietary tool to screen UK stocks on a value basis.
He said Royal Mail had not come up on the screen, which focuses on factors such as sustainable cashflows and high barriers to entry, and was therefore not currently of interest.
‘It is a difficult industry in terms of making money, so that may well hold it back,’ he explained.
‘The [industry’s] return profile and margins are quite low and there is still quite a lot of pressure on those going forward, which could mean an uncertain future,’ he said, adding that this could affect the ability of the company to pay out dividends.
Still to deliver
Although Royal Mail’s substantial share price rise from 330p to 550.7p can be applauded, it has ultimately lowered the dividend yield. Justin Cooper, CEO of shareholder solutions at Capita Asset Services, is keen to point this out.
‘Royal Mail posted a good set of maiden results as a private company, but shareholders who were hoping for a dividend didn’t read the small print of the prospectus which made clear they will have to wait until the full-year results, when the company expects to pay out £133 million.
‘That is still on track for next year, but with the share price having roared ahead since the IPO, it means Royal Mail is now providing a lower yield than quite a lot of the UK’s largest companies.’
It is for this reason that one fund manager who bought into the IPO on the prospect of a decent yield has since sold out. They said the yield, around the 3% level and down from the 6% notional yield at flotation, was no longer high enough.