The last time I covered Royal Mail (LSE: RMG) shares on 22 November, they were changing hands for around 200p. At the time, the FTSE 250 company had just issued a disappointing set of half-year results, and I said that “looking at the challenges the business is facing, I just don’t think the shares are worth the risk” and that I was “steering clear.”
Fast forward to today, and the shares are now trading at around 176p – about 12% lower than they were in November – so avoiding the stock was clearly the right move. Here, I’ll explain why the stock has continued to fall and what I’d do now.
Disappointing trading update
One reason Royal Mail shares have underperformed recently is that the group released a disappointing trading update for the nine-month period to 29 December 2019 last week. While revenue for the period was up 3.7%, and the company said that 2019-2020 group operating profit is likely to be between £300m and £340m (in line with expectations) there were several things in the update that the market didn’t like.
For example, RMG advised that the outlook for 2020-2021 is “challenging”. It also said that the ongoing industrial relations environment and delays to its transformation plan, combined with continuing economic uncertainty, increase “the likelihood” that the UK parcels, international and letters (UKPIL) business will be loss-making in 2020-21.
In addition, the group stated: “Unless we are able to make significant progress in delivering our transformation plan, our ability to meet the year 3 targets of our Journey 2024 plan will be compromised.” Overall, the trading update was not very encouraging.
Analyst sentiment
Another reason RMG shares have fallen recently is that they are still very much out of favour with analysts.
For example, just last week, analysts at Berenberg downgraded RMG from ‘hold’ to ‘sell’, stating that the company is facing challenges from trends in the postal sector such as letter volume declines. Meanwhile, analysts at Jefferies have an ‘underperform’ rating on the stock, on the back of deteriorating letter and parcel volume trends, increasing competition from Amazon Logistics, and rising wage inflation.
Overall, of the 12 brokers following the stock, four have it as a ‘strong sell’, three have it as a ‘sell’, three have it as a ‘hold’ and only two have it as a ‘buy’. And over the last month, the consensus earnings per share forecast for the 2020-2021 year has fallen about 10%. This will have contributed to the share price decline.
What I’d do now
Looking at last week’s trading update, my view on RMG remains the same as it was in November – I think the shares are not worth the risk.
Yes, the stock is cheap. The forward P/E ratio is just 8.3, compared to the FTSE 250 median of 15.5. And yes, the dividend yield is high. Currently, the prospective yield is 8.4%. Yet this is a company that is facing significant challenges right now, so it has a low valuation and a high yield for a reason.
All things considered, I believe there are much better stocks to buy right now.
