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Royal Mail not a buy as competition concerns bite

Royal Mail not a buy as competition concerns bite

Mark Boucher, head of UK equities at Smith & Williamson, has argued Royal Mail is not a buy as the current share price does not compensate for competition concerns.

At 14:20 Royal Mail's share price was down 6%, trading at 537.65 pence following its annual results, in which the postal service reported a £27 million rise in operating profit to £430 million after costs for the year to the end of March. Revenue grew 2%, over the period, in line with expectations.

Commenting on the results, Royal Mail's chief executive Moya Greene warned the company was 'facing a couple of headwinds', in the form of rival companies offering direct delivery.

'The competitive environment on the parcels side is more intense. We are taking steps to remain the leader in this growing market,' she said.

The company has called on Ofcom to look into competition amongst delivery services, complaining that its rivals are cherry picking the most lucrative regions to deliver to, leaving Royal Mail with the regional areas that it is obliged to cater for.

Royal Mail warned that it would not be able to achieve its revenue target of 5-10% if this is not addressed, although Ofcom has suggested the postal service should 'improve efficiency' to combat competition threats.

Boucher says these challenges prevent him from buying into the stock, even at lower levels.

'Royal Mail have grown revenues very strongly over the last few years and we expect that to continue but it's going to be tough for them to carry on cutting costs. We continue to think it is overvalued and there are a lot of risks remaining in the business. Plus they may release another tranche of shares before the next election, which could dampen the share price,' he said.

'I would like to see Royal Mail under £5 before we think about buying it. It's not a business without risk, and I think there are more attractive businesses out there.'

Justin Cooper, chief executive of Capita Asset Services said the case had lessened for the stock since its privatisation and IPO in October, which saw the shares rise by 38% on the first day of trading..

'Most investors flooded into the stock when it floated because the yield looked so appealing. That’s not the case any longer. Even after the sharp fall in the share price after the results were published, the yield is not attractive compared to the rest of the FTSE 100,' he said.

'What’s more, with the management admitting competition is eating Royal Mail’s direct delivery lunch, future profits are at risk. That means future dividends could easily disappoint. Investors may conclude there are better places to find a reliable income.'

But analysts at JPMorgan Cazenove said their long term stance 'remains bullish,' and have not changed their estimates in light of Royal Mail's warnings, as they think the stock is a particular beneficiary of the UK domestic recovery. 

Analysts Christopher Combe and Wenchang Ma said the shares 'offer a combination of exposure to UK and European macro-economic recovery – a trend to which parcels operations are particularly geared'.

They also noted the Royal Mail's announcement of a 1,300 headcount reduction as evidence that the company was committed to cost cutting.

 

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