Royal Mail (LSE: RMG) announced disappointing 2019–20 results today. Profits came in at £161m, down from £175m last year. Investors sold their shares in response, driving the price down by nearly 12%. Royal Mail’s problems did not start this year or last. Profits in 2015 were £328m, and they have gone pretty much straight down since then. The share price has not fared any better, as it was 617p in February 2014 and is 75% lower today. However, after today’s big slump, an investor might be wondering if Royal Mail shares are cheap enough to be worth buying. I am not convinced they are.
To be cheap enough to justify taking the risk, there has to be the hope of a turnaround. I think that the cause of Royal Mail’s problems will not go away.
Delivery issues
When you look at the table below it is clear to see how the revenue sources at Royal Mail have changed over time. This change in revenue sources lies at the heart of the issues facing the company.
| 2015 percentage of revenue | 2020 percentage of revenue | |
| UK Letters | 36% | 31% |
| UK Marketing Mail | 13% | 6% |
| UK Parcels | 34% | 34% |
| UK Operations Total | 83% | 71% |
| International Parcels | 17% | 29% |
Royal Mail is delivering fewer letters and its international operations are becoming more important. But look at how margins and return on equity have changed, in the table below, as a result of delivering less mail and more parcels in the UK and abroad.
| 2015 | 2020 | |
| EBIT Margin | 5% | 2% |
| Net Profit Margin | 4% | 1% |
| Return on Equity | 9% | 3% |
Earnings before interest and taxes (EBIT) and net profit margins were a paltry 5% and 4% in 2015, and have slumped to 2% and 1% respectively in 2020. Return on equity (ROE) was an uninspiring 9% in 2015 and has fallen to just 3% in 2020.
Royal Mail’s management stated today that Covid-19 had accelerated the revenue trends. Those revenue trends appear to be driving profitability, and shareholder returns, lower. Royal Mail’s monopoly on mail does not extend to parcels, where it faces stiff competition. Distribution costs as a percentage of revenue have grown from 19% in 2015 to 26% in 2020.
Bargain or not?
So, unless things change these trends look set to drive Royal Mail into reporting a loss. In fact, change is coming. Management today said that Royal Mail would be axing 2,000 management jobs to cut its wage bill, slashing capital expenditure, and cancelling next year’s dividend in response to today’s reported slump in profits. The company is also negotiating its obligation to deliver letters at a uniform price six days a week.
The question is whether potential investors should be hopeful about the impact these changes will have. Royal Mail has been transforming its operations, at a cost of £719m over the last five years, but has failed to improve profitability. Being able to charge more to deliver letters at the weekend won’t be much help, as letter volumes are falling.
Parcel delivery looks to be a fiercely competitive business, and Royal Mail is becoming ever more dependant on it as letter volumes fall. A cost-saving drive has so far failed to produce any tangible improvement, and I cannot think of a reason why the new one will. This stock might not pay a dividend for years and could soon start reporting operating losses. For me, at least, the Royal Mail share price is still not cheap enough to buy.
