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Royal Mail (LSE: RMG) shares have drastically underperformed this year, falling over 48% year-to-date. For context, the FTSE 100 is down just 4% for the year. Twelve-month returns are even worse, with the stock falling 52%. As recession fears mount, the shares could continue to tumble. However, with it trading on a low 4.3 price-to-earnings (P/E) ratio, is now the time for me to buy this cheap UK stock? Let’s find out.
A great value stock
The low P/E ratio of Royal Mail does attract me. For a start, it’s well below the ‘value’ level of 10, and miles below the FTSE 100 average of 14. In addition to this, it’s far below competitors UPS and FedEx, which trade on P/E ratios of 14 and 16 respectively. All of this signifies that Royal Mail shares could be vastly undervalued at their current price.
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In addition to the low price, the current dividend yields a healthy 6.2%. City analysts expect this number to creep up towards the 10% mark over the next few years as the courier raises its payouts. Therefore, a Royal Mail position could help me add some passive income to my portfolio – something I’m looking to do to keep up with rising inflation.
Why I’m wary
There are risks though. For starters, the state of the UK economy is a big threat to Royal Mail. Interest rates are being hiked to counter red hot inflation and eventually, this is going to slow economic growth. This could translate into less demand for parcels, which is bad news for Royal Mail.
Inflation itself is leading to ballooning costs for the firm too. Last year, transport made up 29% of the group’s costs. With oil prices through the roof, operating expenditure could swell to dangerous levels. With over £2bn of debt on the balance sheet, this is something the courier can’t afford.
In addition to this, the firm is facing huge industrial action issues. The cost of living crisis means workers want larger pay rises. The company has already proposed a 5.5% wage rise, which was recently rejected by workers. Such a rise would push the total wage bill up by over £250m, so the prospect of anything higher than this is pretty dire for Royal Mail. However, if nothing is done, then workers will strike, and the stock will tank. Both choices present pretty bleak situations for it.
Finally, competition in the parcel delivery space is heating up. Overseas giants like DHL are pouring millions into expansion, with DHL announcing plans to create 3,500 new jobs in the UK.
Would I buy?
It’s no secret that Royal Mail shares are cheap and offer a great dividend. However, I think the low share price reflects the tough outlook for the firm. Industrial action and the state of the macroeconomy are pitted against it, and I think these obstacles are going to be hard to overcome. As such, I won’t be adding the stock to my portfolio any time soon.
