Are Royal Mail shares worth buying after the dividend cut?

Trading conditions for Royal Mail (LSE: RMG) have been difficult recently. Increasingly, everything is distributed by email. This goes some way toward explaining why the group announced that operating profits fell 34%, to £376m, in May. 

Unsurprisingly, the company’s share price dropped by a total of 17% in May. To the relief of investors, the price has steadily recovered since June. On a year-to-date basis, however, the results are still quite bleak, with the price down 16%.

This fall in valuation does leaves Royal Mail with an attractive price-to-earnings ratio of 7, and a whopping 7% prospective dividend yield. Being publicly owned in the past, the appeal in owning the shares was the opportunity for greater efficiency and lower costs.

Potential investors will, therefore, be asking how the company’s management will be addressing the falling profits and delivering on lowering expenses. 

Cutting costs

Unfortunately for holders of the stock, Royal Mail boss Rico Back has started to cut costs by reducing the dividend. The annual payout has been slashed 40%, from 25p to 15p, with the understanding that extra payouts will be made if cash is available. I wouldn’t count on that though, with Black confirming that investment plans in the UK mean we should expect lower cash flow in the near term.

My concerns about dividend cuts are eased if a company is using the money to fund growth and invest back into the business. In this case, how will this extra cash be used?

As part of its UK strategy, Royal Mail will invest approximately £1.8bn over five years in the UK postal service. 

There is hope that growth will come from its General Logistics Systems company. This part of the business provides B2B and B2C services in Europe and North America, with the former section being the focus for the planned growth. In its full-year results, GLS reported volume growth of 8%. Black has stated that he wants to build a “parcels-led, more balanced, and more diversified international business”.

Planning for the future

Coming as no surprise, letter volumes are declining, in part due to consumers moving away from posting letters, but GDPR legislation has also had an impact. The drop is expected to be between 5% and 7% next year. This does not include political party election campaigns, which holders of the stock will no doubt be hoping for.

Royal Mail has three key priorities to fulfil its ambition of delivering an operating profit margin of over 4% in 2021-22. The strategy is focussed on growth in the UK, scaling up GLS, and enhancing its cross-border proposition. Efficiency measures are also being made to improve the UK’s network handling of large and small tracked parcels.

This is a sector that I think will continue to struggle. Despite Royal Mail’s strategy and ambition, is enough being done to capitalise on its market position? If a company’s main selling point is the efficiency savings it could make – rather than prospective and ambitious growth – alarm bells ring for me. This is the position Royal Mail is in, I fear.

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T Sligo has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019