With its 13.3% dividend yield, I’d consider buying this share

The FTSE 250 letters and parcel delivery provider Royal Mail (LSE: RMG) saw a crash in share price to a multi-year low of 175p at the last close at the time of writing this. The trigger was RMG’s latest trading update in which it said “The outlook for 2020–21 is challenging”. It also said that its ongoing transformation plan could be impacted.  

Depressed outlook 

It is easy to see why investors lost confidence in the share after the disappointing update, which only adds to the list of Royal Mail’s woes. Its strong workers union and management have been at loggerheads for some time now. Its letters delivery business is facing a structural decline. In fact, it now expects its UK parcels, international, and letters (UKPIL) business to be loss-making in 2020–21. This business accounts for 45% of RMG’s operating profit according to its November update. More bad news on this front will weaken RMG further.  

High dividend yield       

But the flipside of the steep share price drop is the increase in dividend yield, which now sits at a huge 13.3%. In other words, if I invest in Royal Mail today, I could stand to gain this much income on my capital. But the operative word here is “could”. The income depends on whether the company will maintain this level of dividends.

Let’s consider the worst-case scenario. The company cuts dividends by 40%, the same rate at which it cut them last year, from 25p to 15p. With this further cut, the dividend would amount to 9p or 5.1% at the current share price. This doesn’t exactly make it the best dividend stock around, but it’s far from being the worst either.  

The average dividend yield for the FTSE 100 set of companies is 4.3%. For the FTSE 250 set of companies, it is 2.9%. This means that RMG’s dividend is a shade better than the FTSE 100’s and significantly better than the FTSE 250’s. And this is when we are assuming the worst case. If RMG continues with the current dividend policy or cuts dividends less, then the yield is even higher. 

Dividend continuity?

But for long-term investors, another question comes into play. Is there is a scenario in which Royal Mail won’t be able to sustain its dividends at all? If the UKPIL business drags the entire company into becoming a loss-making entity, it could conceivably happen.

It’s a wait-and-watch for now, I think. It’s important to remember that RMG has paid dividends consistently in the past and has been profit-making.  

Investors in RMG shouldn’t panic and sell in my view, but hold for now and see how this story plays out. For income investors, RMG looks attractive but risky right now. I’d be sure to consider it carefully, but also look at far less risky options. The FTSE 100 itself boasts more than one company with relatively rich dividends and greater expectations of stability.

The post With its 13.3% dividend yield, I’d consider buying this share   appeared first on The Motley Fool UK.

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Manika Premsingh 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.

Motley Fool UK 2020