Royal Mail receives another sell note as cost pressures mount

Royal Mail PLC (LSE:RMG) has received its second sell note in two days, as Credit Suisse downgraded the postage company to Underperform and downgraded its price target by more than a third.

The broker’s analyst Hannah Burrows said the market was paying for a sustainable 5% EBIT Margin at Royal Mail, but that Credit Suisse considered its normalised margin profile to be 4%, which when coupled with meaty investment requirements, left shares overvalued.

Credit Suisse downgraded its price target to 345p from 558.11p previously.

Burrows said five key headwinds were driving its gloomy outlook for the group, the primary one being downside risks to parcel growth, with Credit Suisses projecting a 0.5% volume decline in parcels in 2022-23.

“We believe only a partial normalisation of online shopping habits occurred in 2021-22 and we estimate that reduced testing kit volume and an end to isolation requirements could alone drive a 5% headwind,” Burrows said.

Labour cost inflation was also expected to weigh on the company’s margins in light of a new pay deal for Royal Mail employees, with forecast 5% increase in labour costs above current consensus of 3%, pushing margins to 6.9% against previous expectations of 8.1%.

Credit Suisse also believes Royal Mail’s history of suboptimal levels of investment will catch up with the company, particularly as the need to decarbonise its fleet gathers pace, adding £84mln in additional capex costs to the broker’s financial model.

The gloomy outlook adds to a sell note issued by Liberum yesterday that downgraded Royal Mail’s price target from 470p to 355p, following negotiations for a pay rise for Royal Mail staff that could match high inflation.

“With RPI currently at 7.8%, we see a risk of a margin squeeze for the group if a pay deal is agreed anywhere close to that level,” the broker said.

“Even linking a pay hike to productivity might not be enough to defend margins, with a 3% improvement being the best the UK business has achieved.”