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Between the beginning of April 2020 and June 2021, the Royal Mail (LSE: RMG) share price added more than 375%. Over the past year, the stock has returned 75%, excluding dividends.
However, since topping out around 591p at the beginning of June, shares in the company have declined by 28%, excluding dividends.
Following this performance, the good news is that the stock has been treading water since the beginning of October. And I think this is a sign that the market has started to realise that the company has become too cheap.
Royal Mail share price potential
Over the past 24 months, Royal Mail has gone from a corporation investors love to hate to a market darling. Surging parcel volumes throughout the pandemic turbocharged group profits and transformed the company’s outlook.
Unfortunately, the growth was never going to last. Group income jumped 285% in its last fiscal year. That sort of growth is not sustainable, and I think the market realised this. I reckon this explains why the stock has been falling recently. The market seems to have got ahead of itself, and it has been correcting this mistake.
Now that Royal Mail’s valuation has fallen, investors seem to be returning, or at least they are not leaving anymore.
I think investor sentiment is also improving, thanks to the group’s recent acquisition in Canada.
Overseas acquisition
Two weeks ago, the postal service’s international division, GLS, bought Canadian firm Rosenau Transport.
The deal will link its Canada and US services. The £210m deal provides significant growth opportunities for the group and a substantial foothold in North America.
I am excited by this deal for two reasons. It will help Royal Mail diversify outside of its home market, where it is obligated to provide a certain level of service no matter what the cost. It will also bulk up the North American business to provide a jumping-off point for the group to expand further across the region.
I think it is also encouraging to see the company spend some of its pandemic windfall growing overseas. A large chunk of the money is already earmarked for investment here in the UK to upgrade Royal Mail’s ageing infrastructure.
Growth headwinds
While I am encouraged by the company’s current growth plans I think it is also important to consider the risks the organisation may face going forward.
These include rising wage and infrastructure costs, as well as competition. As noted above, Royal Mail is obliged to provide a certain level of service in the UK. This puts the company at a disadvantage to competitors, who can pick and choose the most profitable regions.
Still, despite these challenges, I would buy the stock for my portfolio today. After a period of consolidation, I think the shares now look cheap compared to Royal Mail’s prospects, especially considering its overseas expansion plans.
As the group starts to reap the results of its capital investment and overseas growth, I think the stock should reflect this.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
