Here’s why I think the Royal Mail share price is 70% undervalued

This Fool explains why he thinks the Royal Mail share price could be worth 70% more than its current price, based on peer comparisons.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Close-up of British bank notes

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Royal Mail (LSE: RMG) share price has been a standout performer over the past couple of years. From a low of 124p printed at the beginning of April 2020, the stock pushed to a high of 600p at the beginning of June 2021, a return of 380%.

Unfortunately, over the past year, this performance has deteriorated. Over the past 12 months, the stock has returned just 7%. Year-to-date, the performance is even worse. Even though the year is just a few weeks old, the stock has declined 15%. 

It seems there are a couple of reasons why the shares have slumped. However, I think this could be an opportunity for long-term investors as the stock seems to me to be undervalued at current levels. 

Royal Mail share price headwinds 

Whenever I analyse a stock that has been underperforming, I always try to understand the reasons behind the decline before moving on to the valuation process. 

Royal Mail is currently facing multiple headwinds. The most pressing is the disruption from the pandemic. Around 15,000 (10%) of the group’s staff were off sick or isolating in early January. That would be a considerable challenge for any company, let alone one that delivers parcels and letters daily to customers. 

As a result of this disruption, costs have jumped. Between April and December of last year, the firm has had to fork out £340m on overtime and temporary staffing solutions. And even this spending has not prevented significant delivery delays. 

The group is also facing growing competition from rivals. This has always been a change, but it seems as if the competition is intensifying. To try and deal with this challenge, the group recently outlined plans to cut 700 more management jobs. These cuts will incur a one-off charge of £70m but can deliver annualised savings of £40m. 

Company valuation

Considering these headwinds, I can see why investors have been taking profits. Still, I think it is a mistake to concentrate on the company’s challenges without analysing the opportunities. 

As demand for delivery services booms, thanks to the growing e-commerce market, Royal Mail’s profits are expected to continue to grow for the next two years. Based on City projections, shares in the corporation are trading at a 2023 price-to-earnings (P/E) multiple of 7.2.

That looks relatively cheap compared to this company’s growth potential. I think it also undervalues the business’s competitive advantages. Royal Mail is one of the most recognisable brands in the country, and its countrywide delivery network is virtually unrivalled. 

I think these advantages deserve a premium evaluation. How much of a premium? Well, European peer Deutsche Post shares are selling at a forward P/E of 12.4. I do not think it is too unrealistic to say that the Royal Mail share price could command a similar multiple.

On this basis, I believe the stock could be undervalued by as much as 72%. Although this is the most optimistic scenario, and there is no guarantee the stock will rise 72% from current levels, I would buy the shares for my portfolio today, considering this valuation discount. A potential dividend yield of more than 5% also looks attractive. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves 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.

More on Investing Articles

Investing Articles

How much would I need to invest in income shares to earn £300 a month?

What kind of lump sum would be required to earn £300 a month by taking advantage of some of the…

Read more »

Investing For Beginners

Up 31% in a month, could this FTSE 250 stock be getting bought out?

Jon Smith takes a look at speculation that's pushing the share price of a FTSE 250 share higher and considers…

Read more »

Investing Articles

Here’s how I’d follow Warren Buffett to start building passive income in 2025

Ben McPoland highlights one FTSE 250 firm with a strong competitive edge that he thinks can continue rewarding investors with…

Read more »

Investing Articles

Burberry shares: undervalued FTSE gems that are ready to rocket?

Burberry shares soared at the beginning of the week as the takeover rumour mill went into overdrive. Is Paul Summers…

Read more »

US Stock

Here are the latest share price forecasts for S&P 500 giant Amazon

Amazon has generated monster gains for investors over the last decade. And Wall Street analysts believe the S&P 500 stock…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

2 high-yield FTSE 250 shares I’d buy today — and 1 that I’d avoid

UK markets have felt some volatility after last week’s Budget and the FTSE 250 was no stranger to it. Our…

Read more »

Investing Articles

3 reasons the Rolls-Royce share price could soar over the next decade

Sustainable aviation fuel, narrow-body aircraft, and small nuclear reactors could all keep the Rolls-Royce share price climbing over the next…

Read more »

British flag, Big Ben, Houses of Parliament and British flag composition
Investing Articles

Here’s how much income I’d get if I invested my entire £20k ISA in cheap BT shares

BT shares are on the up but still cheap, while the FTSE 100 telecoms stock offers a good yield too.…

Read more »