What does Royal Mail’s profit downgrade mean for investors?

What’s happened?

Royal Mail PLC (LSE:RMG)  has cut its profits forecast in its UK arm this year down to £430mln from £500mln.

At the same time, Royal Mail announced plans to shed 700 managerial jobs as part of a reorganisation plan.

The axe swing will cost Royal Mail around £70mln to save £40mln per year. So, technically, underlying operating profits are maintained at £500mln.

It noted that trading has been impacted since December due to staff absences caused by Covid, and the Omicron wave.

Revenue in the third quarter to end December 2021 fell by 2.4% to £3.55bn, with UK parcel volumes down by 7% and letters by 3% compared to 2020.

During the period it spent £340mln on overtime, additional staff and sick pay.

Chief executive Simon Thompson highlighted that the absence rate in early 2022 was around two times pre-COVID levels.

It matters because …

Royal Mail is still handling huge volumes of parcels for e-commerce through the pandemic, but, it is struggling to deliver letters to households.

The formerly national postal service is obliged to uphold certain service levels and it has been revealed that it received 1mln complaints last year, ended March 28, mostly due to delay.

It represented the highest level of complaint for more than a decade.

Key delivery targets were missed with a quarter of first-class deliveries not arriving the next day (measured against a 93% target), meanwhile postal costs increased 21% in the year, with a first-class stamp now costing 85p.

At the same time, the rise in online shopping effectively makes Royal Mail the UK’s default courier for website shoppers, sending parcel volumes soaring during and since lockdown.

Royal Mail struggled operationally as more than 15,000 postal workers missed work in early January due to the Omicron wave of Covid, and, it was further squeezed because at the same time it was responsible for delivering some 1.5mln covid test samples under a £790mln government contract

At one point in early 2022, some 77 postal districts were not receiving post regularly. Simon Thomson says that is now improving and the affected number of districts was down to ten.

As posties are already short in number the company it appears Royal Mail is looking up its hierarchy to cut costs.

Market reaction

Evidently, the market welcomed the news that the executive team is making attempts to rein in costs.

Royal Mail shares are up 3.69% changing hands at 453.4p

Meanwhile, the profit downgrade and Royal Mail’s recent troubles were largely priced in with the share falling some 13% over the preceding month.

What brokers say

Royal Mail’s trading performance comes against tough comparisons, as in the prior period the parcels business saw a ‘lockdown boost’, that’s according to Russ Mould, investment director at AJ Bell.

A like-for-like decline in volumes is “only to be expected”, he said.

“For a few years Royal Mail PLC (LSE:RMG) was delivering like the worst postie in the depot, parcels marked fragile launched over hedges, letters delivered to the wrong houses and so on, as it really struggled to modernise the business,” Mould added. “Now, helped by the massive growth in parcels being sent during the pandemic, it finally seems to be getting its act together.

“Royal Mail’s latest update showed the firm is continuing to drive efficiencies with plans to cut a further 700 management jobs.”

The investment director and stock market pundit cautioned, however, that Royal Mail may need to careful.

““In streamlining the business, Royal Mail needs to ensure it doesn’t go too far and diminish its operational capability or spark widespread industrial action, the threat of which has hung over the business in the past.”