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When Royal Mail parent International Distributions Services PLC (LSE:IDS) called for a reduction in its letter delivery services it painted a “a picture of financial distress that is not reflected in current consensus forecasts”, analysts said.
Following the calls from the delivery group for all non-first-class letters and bulk mail to be delivered every other day, plus “more realistic” timeliness targets, an “urgent” deadline for pushing the changes through and a “temporary contribution” from the government to help with costs of the USO, two sets of analysts reiterated their ‘sell’ ratings on the shares.
These were Deutsche Bank, which has a target price of 160p versus the last close price of 236.4p, and Liberum, where the target is 180p.
Deutsche’s Andy Chu noted that Ofcom estimates that it costs Royal Mail £1-2 million every day to provide a universal postal service to the UK, while IDS said the declining letter volumes and cost inflation means its UK business faces sustainability challenges.
He said Royal Mail expects no compulsory redundancies and less than 1,000 voluntary job cuts, with the creation of a more efficient network leading to a net reduction of 7,000 to 9,000 daily delivery routes over 18-24 months, with his estimate that there are currently a total of around 56,000 routes.
IDS, in publishing a summary of Royal Mail’s response to regulator Ofcom’s consultation on the reform of the universal service obligation (USO) launched in January, has proposed a higher service level for first class compared to the options outlined by Ofcom.
One of the key elements of IDS was that its proposed changes can be implemented by the regulator without legislative change.
“We see this as sensible,” said Gerald Khoo at Liberum. “Requests to change the specification of the USO, which inevitably result in a lower level of service for the same (or a higher) price, offer an asymmetric political payoff skewed entirely to the downside.”
Nevertheless, he said he believes Ofcom “would be reluctant to choose a controversial course of action without implicit political support”.
While Royal Mail complains about a lack of sustainability, it is not a very efficient organisation, Khoo noted, failing to achieve the operating margin between 5% and 10% seen by Ofcom as consistent with a fair economic rate of return for several years.
Currently, the UK business is materially lossmaking, having made a £419 million operating loss last year, with a slightly smaller £341 million loss forecast for the just completed year to March – although Khoo noted that USO activities are only part of the division.
“However, Royal Mail is neither an effective nor an efficient operator. It has repeatedly missed its quality of service targets and its industry-leading terms and conditions for staff have not extracted commensurate productivity from them,” the Liberum analyst said.
“Until Royal Mail puts its house in order on one or both of these fronts, it is unlikely to get a sympathetic response on USO reform.”
Moreover, the submission to Ofcom which stated “the very real and urgent financial sustainability challenge” Royal Mail faces, says Khoo “is despite the significant efforts to transform the business, which are not limited to the working practice changes in the deal that ended the most recent industrial dispute.
“The business clearly has an incentive to create a sense of crisis when urging the regulator and the government to act.
“However, we believe the outlook is much worse than implied by consensus forecasts, which appear to imply a return to profitability at Royal Mail in FY2025E and further improvements beyond.
“We believe that this is not the self-help turnaround situation that the bulls of the stock would have you believe.”
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