Royal Mail PLC must improve worker relations and productivity to recover margins, says Liberum

() has no “easy or attractive” options to restore margins as it battles turbulent unions and the worsening decline in letters being posted, according to broker Liberum Capital, which has cut its target price for the postal carrier.

In a note to clients, analysts at Liberum reiterated a ‘sell’ rating on the stock, and cut their target price to 175p from 185p in the wake of the company’s recent half-year results.

The FTSE 250-listed firm is fighting an ongoing decline in its letters division, stagnant productivity, and increasing costs from its unionised labour force, which recently voted to go on strike over low pay and pensions.

READ: Royal Mail sees “significant increase” in strike risk over Christmas, parcels growth offsets letters decline

Royal Mail’s chief executive Rico Back warned last week that the group’s UK business could slump to “a break-even or loss-making position” in 2020-21 as the firm booked 13.2% lower profits of £165mln in the first half of its current year as margins dropped 70 basis points.

The analysts were cautious on the stock, saying a “continued decline of margins into lossmaking territory” could not be ruled out unless the next period sees some currently-unexpected “co-operation from the union and staff”.

Last week, Royal Mail said there was a “significant increase” in the risk of strikes as it heads into the busy Christmas period, since the Communications Workers Union (CWU) has now appealed the High Court’s previous decision to block proposed industrial action over issues with the ballot process.

On the other hand, the Liberum analysts pointed out that if unsuccessful in its appeal, the union will have to run a new ballot to seek a mandate for strikes, which would then be delayed until after the peak Christmas – and now election communications period – is over.

“This reduces substantially the financial impact of any strikes,” the analysts added.

But Royal Mail’s woes don’t end there, they added, as “moderately encouraging” 5% revenue growth is still being “more than offset by cost inflation”, as improvements in productivity are struggling to keep margins up.

“Although H1 saw productivity gains return to their previous 2- 3% run rate (+2.2%), this was barely half the rate that was needed given the additional headwind from the full year effect of the October 2018 working week reduction,” the Liberum analysts said.

Staff wages account for 68% of its UK operating costs, and they noted that as long as there are no further reductions in the working week, and Royal Mail mantains 2-3% productivity growth, “cost headwinds should moderate from H2 onwards”.

In spite of the target cut, Royal Mail shares were up 2.3% to 212p in late morning trading.