Royal Mail slump overdone?

Royal Mail has had an eventful 12 months. Floated almost a year ago at 330p amid incredible interest and controversy in equal measure, the share price quickly topped 600p. But then it all went wrong, and the business is worth a third less than it was in February. Now, one analyst thinks the sell-off has gone far enough.

Just a week ago, rival UK Mail warned that parcel volumes were still falling, raising concerns about an industry-wide slowdown. Dutch peer TNT Express is having similar problems in Europe. Royal Mail itself had already warned in July that parcel revenue had dropped amid fierce competition.

The strong pound is a big concern for UBS, too, affecting the translation of profits made at Royal Mail's European parcels operation General Logistics Systems (GLS) back into sterling. Expect flat operating profit margins here, says the broker.

"RMG faces a number of challenges, including modernising its network, managing the decline in letter mail volumes, the threat from competition in both letter and parcel, as well as dealing with a highly fixed cost base," reckons UBS. "We believe RMG faces particular issues with having a highly unionised, relatively well paid workforce at a time when its revenue visibility is low and when both the letter and parcel markets are undergoing significant change."

It's cut earnings per share (EPS) estimates for the year to March 2015 by 6% to 30.1p due to weakness in UK parcel as well as updated FX forecasts. Next year it's after 33.4p and 35.3p in 2017, 8% less than before.

"Having said all this we believe the poor share price performance and valuation largely reflect the fact these negatives are known by the market," UBS concludes.

That's why it's price target is cut from 450p to 400p, but the rating goes up from sell to neutral.

"RMG trades on 5.3x CY2015 EBITDA, 12.3x P/E versus peers on 3-8x and 7-16x. However, we regard RMG as more of a work in progress than the likes of Austrian Post, bpost, and Deutsche Post," concludes the broker.

Royal Mail shares have plunged by 16% since we raised concerns in July. The switch to online shopping in recent years should guarantee a merry Christmas for the parcels division, and there's a prospective dividend yield of over 4%. But that rating still looks generous given persistent headwinds.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.