By the time you read this, you will have less than 24 hours to secure a potential 6% dividend yield.
You see, at 11:59pm today, Tuesday, 8th October…
…your chance to bag quite possibly the best large-cap buying opportunity of the year will be gone.
I am of course talking about the flotation of Royal Mail, the full details for which were announced the other week and the application deadline for which is now fast approaching.
(Editor’s note: the 11:59pm deadline is for applications via the government’s www.gov.uk/royalmailshares facility. Applications through intermediaries may close earlier. Please check with your broker.)
I have read the 447 pages and have
submitted my own application
During the last few days I have ploughed through Royal Mail’s 447-page flotation prospectus on your behalf.
I must admit, I have not read every single word. But I have read enough to see the upside potential… and submit my very own application for the shares.
However, press reports and bulletin boards suggest a lot of other people have also seen the potential gains on offer.
So I am pretty sure the flotation is going to be oversubscribed and applications will be ‘scaled back’.
In fact, I suspect everybody applying could simply end up with the minimum £750 investment, which at the top of the 260p-to-330p price range would give us just 227 shares each.
The final allocation should be announced on Friday.
Anyway, I’ve done my own sums and research on Royal Mail and I’m happy to share them with you today.
Indeed, in a minute I’ll tell you about the group’s very exciting property angle. But first, that dividend.
My sums are based on a £3.3bn market cap
and a 330p share price
Royal Mail reckons it would have been on track to pay a £200m million dividend for the year to March 2014 had it been privatised before April.
So collecting £200m from a £3.3bn market cap gives us that 6% yield.
But is the payout safe? I think it is.
You see, operating profits before restructuring costs came to £690m during the twelve months to June. Then subtracting a conservative £50m for interest costs and applying tax at a rough 25%, underlying earnings could be about £480m.
That projection suggests the £200m dividend would be covered more than twice by post-tax profits, which I reckon gives Royal Mail plenty of room for manoeuvre with its payout.
My £480m projection also places the shares on a P/E of less than 7, which looks very good value to me.
A few positives about borrowings and pensions
A quick look at the prospectus small-print shows a few positives about borrowings and pensions.
In particular, I see Royal Mail has plenty of headroom with its banks, with the group’s new refinancing facilities limiting its net debt to three times EBITDA.
Given net debt is currently less than one times EBITDA, the loan covenant suggests the banks are quite comfortable with Royal Mail’s current financial situation, which is reassuring.
On the pension side, the liabilities for the defined-benefit scheme were all burdened with the taxpayer last year.
But Royal Mail is still on the hook for additional liabilities created by fresh actuarial projections. That said, ‘deficit contributions’ to the scheme are not currently due and, if needed, will be limited to £50m a year from 2016. I like that ceiling.
Could Royal Mail be sitting on
surplus property worth £1.2bn?
The best bit of Royal Mail’s balance sheet involves property.
Now the books show freehold property valued at £793m.
But the prospectus does reveal three central London sites – at Paddington (1 acre), Farringdon Road (8 acres) and Nine Elms (14 acres) – are earmarked for redevelopment and sale.
How much could those three sites be worth?
Well, Royal Mail sold a 2.3 acre site located near Oxford Street for £120m two years ago – implying an acre of prime London land could be worth more than £50m.
So assuming the same rate applies for those 23 acres under redevelopment, the value could be something close to…
…£1.2bn, or 120p per share! Wow.
I expect the shares to start trading well above 330p
So there you go – a decent yield, a low P/E, reasonable debt levels and substantial freehold assets.
On those numbers at least, Royal Mail’s shares look very cheap to me. And to secure that 6% yield, you must act now and apply before tomorrow’s deadline…
…as I expect the price to trade well above 330p when full dealings begin next week.
The top line could be set to lose £450m a year
Finally, it goes without saying that no investment is a guaranteed winner.
Royal Mail has numerous risks, not least the possibility of union strike action in the short term and fewer letters being posted in the long term.
On the latter point, the prospectus reveals a 1% drop in letter and parcel volumes would reduce annual sales by £75m.
Letter volumes have actually been falling by 6% a year, so the top line could be set to lose £450m per annum… which would soon wipe out current profits.
Clearly parcel volumes will have to increase to offset the lost letter income, and thankfully parcel volumes have been advancing at 5% a year and have so far acted as a counterbalance.
But if parcel numbers ever stagnate and letter volumes continue to drop, Royal Mail’s profits – and the share price – will be in trouble.
But with the shares priced at up to 330p, I am happy to accept this risk and all the other dangers… at least for now.
Until next time, I wish you happy and profitable investing.
