How will stamp price hikes impact Royal Mail shares?

Royal Mail parent, International Distrubtions Services, had a challenging 2022 with ongoing postal strikes and falling letter volumes. Now it is raising the cost of a first-class stamp to over £1, potentially further denting demand.

– First class stamps priced above £1 could hit Royal Mail demand and share price.

– Letter volumes in long-term decline.

– The iShares US Transportation ETF is up 5.4% year-to-date.

UK postal service Royal Mail’s, now known as International Distributions Services (IDS) [IDS.L], decision to raise the prices of postal services in an effort to temper soaring costs has led to a fall in its share price.

Shares in the company dropped 0.8% when it announced that the price of a first-class stamp will jump by 15p to £1.10 on 3 March. It also said that second class stamps will rise 7p from 68p to 75p, with new prices coming into effect on 3 April. The stock ended the week down 7%.

The cost of a UK first-class stamp has soared 64% in the past five years, well past the rate of inflation, making sending a letter less appealing for stretched consumers. Some believe it’s a sign that posting a letter in future could become a niche, premium service.

The IDS share price is up 3.6% year-to-date, but is down 4.7% over the past month. It’s a long way from 2021, when it soared as high as 613.80p on 7 June during a mid-pandemic lift.

Postal strikes hit Royal Mail profits

Royal Mail pinned the price hike, which means a first class stamp will exceed £1 for the first time, to reduced demand and growing costs due to the overall macroeconomic climate.

“We have to carefully balance our pricing against a continued decline in letter volumes and the increasing costs of delivering letters six days a week to an ever-growing number of addresses across the country,” said Nick Landon, Royal Mail’s chief commercial officer.

At the end of January, Royal Mail posted its third quarter (Q3) earnings and earnings for the nine months to the end of December 2022. The report showed revenues were down 12.8% year-over-year during the nine-month period, with total letter revenues falling by 6.1%. Parcel revenues dived 17.8%, and year-to-date adjusted operating loss sat at £295m.

A number of strikes by postal workers have had an impact. In January, Royal Mail said the net cost of strike action for the nine months to December 2022 was £200m. It added it expected adjusted operating losses of £350 to £ 450m for fiscal year 2022-23, with 18 days of strikes being six more than the company had anticipated.

Lower letter volumes ongoing challenge

Royal Mail has experienced a growing number of competitors for parcel deliveries such as DHL [DPW.DE] and privately owned Yodel. DHL recently announced its revenues had jumped by 15.5% year-over-year to €94.4bn, in what were termed “record” results.

There have been other challenges. In February, Royal Mail’s overseas deliveries were interrupted for six weeks following a cyber attack in which it refused to pay an £67m ransom demand.

Meanwhile, members of the Communication Workers Union voted in favour of more industrial action last February.

Royal Mail is set to cut up to 10,000 full-time equivalent roles by August to make up for losses in the face of dwindling demand. The company said in January there would be no compulsory redundancies, but investors will be watching closely to see if it can make the books balance.

US service FedEx [FDX] is set to deliver its Q3 results later this week, and, like Royal Mail, is expected to post a decline following a mid-pandemic boost.

Funds in focus: the iShares US Transportation ETF

IDS stock is not currently held in any ETFs. However, investors seeking exposure to delivery service companies could look at the iShares US Transportation ETF [IYT], where FedEx is the fifth-largest holding with a weighting of 5.14% as of 10 March. The fund is up 5.4% in the year to date, but down 4.8% over the past month.

As for IDS, a consensus of 13 analysts polled by Refinitiv are offering a 12-month median price target of 260p, which represents a 13.6% upside from the stock’s recent close of 228.80p. Of 14 analysts rating the shares, two recommend to ‘buy’ IDS, two offer an ‘outperform’ rating, seven advise to ‘hold’, one rates them ‘underperform’ and two ‘sell’.