After the privatisation party, a share-price hangover for Royal Mail (LSE: RMG) was inevitable. The stock is down nearly 6% from its peak of 597p, and now trades at 563p. That is still more than 70% above its 330p flotation price, but the question is where the share price goes from here. The quick gains have been banked. Now management has to knuckle down to the nitty-gritty of building the business and driving shareholder value. It has become commonplace for people to say Royal Mail is purely about the yield, but it isn’t much of a yield. Right now, the stock is on a forecast 2.8% for March 2014, well below the FTSE 100 average of 3.5%. This isn’t a top income stock.
I wouldn’t be too downcast about that income. Royal Mail is on a prospective 4.2% yield for March 2015, rising to 5% the following year. Earnings per share growth forecasts look promising at 30% and 15% in the years to March 2015 and 2016. Investors will be happy if it can deliver that. Royal Mail certainly has plenty of challenges, as it presides over an irreversible decline in its letters business. On the plus side, its UK Parcels and GLS Divisions now account for just over half of group revenue, and this is where the growth prospects lie. Parcel revenue recently rose 9% to £1.48 billion. Competition is fierce, however, and investors shouldn’t underestimate the challenges.
Right Royal investment
There are good reasons to invest in the Royal Mail. That Christmas strike action never happened. Unions secured a generous 9.1% pay rise over three years and employee protection guarantees, but accepted curbs on their right to strike in return. That should boost investor certainty. Its parcel business should benefit from rapid growth in online shopping. Operating margins have steadily increased over the past three years. It has a strong brand. The legal obligation to maintain a universal postal service for UK mail may prove a drag, but it underlines the scale and coverage of the business. The dividend policy should be progressive.
I don’t expect Royal Mail to “do a Facebook”, in the industry jargon, and lose a quarter of its value within weeks of floating. I suspect many investors are in this for the long-term income haul, rather than the short-term growth hit. But I wouldn’t be surprised to see further slippage in the weeks ahead. Some pension funds have already sold out of the stock, believing it can’t justify its current valuation. I have some sympathy. I wouldn’t buy Royal Mail today, because there is a fair chance it will settle at a lower valuation as it loses its novelty value. That would be the time to buy.
