Royal Mail emerging from state utility legacy

Comparisons, as they say, are odious. That certainly applies where Royal Mail (RMG) is concerned. Domestic parcel volumes have risen by a third on pre-pandemic levels, so it’s difficult to arrive at a like-for-like measure. The real questions are how the privatised utility has responded to the surge, and the extent to which volumes will pull back as we move forward.

Of course, both industry analysts and increasingly anxious consumers will be wondering if the group has the capacity to deal with the upcoming Christmas season, particularly if the structural shift in parcel volumes is gathering momentum. It may be that shoppers will be glad to get back on the high street, but it is hard to imagine that e-commerce traffic hasn’t been permanently altered by Covid-19.

Reports have already emerged about certain areas in the UK which have experienced postal delays, but given general labour and supply chain issues we shouldn’t be too surprised. Further afield, the Amsterdam-based General Logistics Systems (GLS) business has seen a 30 per cent increase in parcel volumes since the virus took hold, but it will have to contend with the reintroduction of Covid-linked restrictions in the Netherlands and other European markets. Conceivably, this could increase cost pressures, though GLS is starting to see a recovery in its core B2B parcel business.

That underlines the chief determination: will the virus prove to be beneficial to Royal Mail’s business model over time? For investors, might pros finally outweigh the cons? One thing we can say is that given the capital-intensive nature of the business, its balance sheet remains in remarkably good order. So much so, that management intends to dole out special dividends and buybacks to the tune of £400m.

Judging by the price movement on results day, these returns have been welcomed by shareholders. But some may wonder why this capital hasn’t been ploughed back into the business given the ongoing push towards automation. Consider that just 12 per cent of parcels were delivered through automated processes prior to the pandemic. That had grown to 40 per cent in the first week of November 2021, and is expected to hit 50 per cent by the end of the year.

The business has shaken off a lot of the excess baggage that came with privatisation, and increased automation is driving both capacity and margins. A prospective dividend yield approaching 4 per cent and a lowly forward rating of 8 times adjusted earnings may be worth a speculative punt, but legacy issues persist, so we will wait for the dust to settle after Christmas. Hold.

Last IC view: Hold, 516p, 21 July 2021