Royal Mail: is it time to be optimistic?

Sentiment towards Royal Mail is picking up. Shares in International Distributions Services (IDS), which is made up of Royal Mail and European courier GLS, have risen by more than 10 per cent over the past month, and have made sustained gains since September last year. 

A key piece of good news has come from Ofcom. The communications regulator is now preparing to advise on how the universal service obligation (USO) – which requires Royal Mail to deliver letters six days a week to every address in the UK –  “might need to evolve to more closely meet consumer needs”. It plans to set out its findings later this year. Royal Mail has argued for a five-day requirement. 

Another important boost came from JPMorgan. The bank has upgraded IDS from “neutral” to “overweight” and has increased its price target from 300p to 310p, arguing that the UK business is “at an inflection point, both on revenue and costs”. 

The regulator’s intervention helped to shape its decision. “We are aware that Ofcom is now consulting on options to change the USO. We expect these changes to… include a move to delivering letters five days per week, compared to the current requirement for six days.” The bank concluded that this would be “very material”. One potential block to this is the government signing off on the change – business and trade minister Kemi Badenoch said this week she didn’t have “any plans to change the USO”, although added she would consider Ofcom’s advice. 

There are other encouraging signs, beyond a potential USO change. The agreement reached with the Communication Workers Union (CWU) in July “gives some stability”, JPMorgan said, and should allow the courier to win back some of the market share it lost during the strikes. 

The bank expects parcel revenues to increase between now and 2025 as customers put off by poor performance in recent years come back, and the recent hike in the price of stamps should also help the top line. This sales growth will be crucial, given Royal Mail’s operationally geared business model. 

There are still plenty of potential pitfalls, however. For starters, there is no guarantee that Ofcom will push for the terms of the USO to be loosened and, even if it does, any changes will require parliamentary approval. This is unlikely to be quick. 

In the meantime, revenues are still falling and JPMorgan is forecasting an operating loss of £295mn for FY2024, including £50mn of voluntary redundancy costs. And while it expects a “sharp recovery in profitability” in FY2025, there is very little evidence so far of revenue improvements or major cost savings. Indeed, the CWU pay deal is expected to increase Royal Mail’s annual costs by around £350mn. 

Valuation is also a knotty point. JPMorgan values GLS on an EV/Ebit multiple of 12, meaning the implied value of Royal Mail is “near zero or even negative”. This sounds like a very attractive entry point. However, if the recovery story doesn’t pan out as hoped, there is a chance that the UK business will actively hinder GLS, particularly when it comes to dividends and debt repayments. 

IDS’s interim results are due to be published on 16 November.