The Royal Mail (LSE: RMG) share price has fallen 52% over the past 12 months. It means we’re looking at a 35% decline over five years, and at one of the FTSE 100‘s most volatile stocks over that timescale.
Billionaire investor Warren Buffett urges us to look for great companies at fair prices. Although I wouldn’t describe Royal Mail as a great company, it must be good to buy fair companies at great prices too, mustn’t it? Does that make Royal Mail a buy now?
The share price alone is never a good indicator of whether to buy a stock, even if it does look something like this:
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To put it into context, I’m going to look at a couple of things. Firstly, is valuation. Based on last year’s earnings, Royal Mail shares are on a trailing P/E of just 4.7.
It doesn’t help that analysts are predicting an earnings drop this year. But it would still raise the P/E to only around seven, and the City is expecting earnings growth the following year.
Dividends look good too. After a 5.6% yield for 2021-22, forecasts suggest 7.8% this year, rising above 8% next. On those measures in isolation, Royal Mail shares look like a steal to me.
Mixed results
But when a share price looks this cheap, we have to ask what sent it down that far. And checking full-year results to March 2021, I can see why investors might be turned away.
Most of the key headlines look fine. Revenue was largely flat, adjusted operating profit rose 8%, EPS lifted and the dividend doubled. But then I hit the crunch figure. Debt. This more than doubled over the year, to £985m.
That takes the edge off the valuation figures. Adjusting for the debt to work out an enterprise valuation brings the trailing P/E up to 6.5. And the forecast for the current year looks to be about 9.5.
That still leaves the Royal Mail share valuation looking reasonably heathy. But perhaps not quite the screaming bargain it first appeared.
Cash management
It leaves me wondering one thing. Why would a company seeing debt soaring while its cash levels drop decide to double its dividend? It also makes me think the £400m returned to shareholders over the past five years might have been a bit premature.
It’s perhaps unfair to blame Royal Mail for not foreseeing the current economic pressures and soaring inflation. But that’s why I like companies to be conservative with their cash management and to maintain a buffer. It’s because unexpected things come along when we, erm, don’t expect them.
The company is embarking on some ambitious cost cutting. And I expect it will get back to earnings growth once the latest economic crisis is weathered.
With the medium-term risk, I would not rate Royal Mail a no-brainer buy today. But if it can reverse its cash direction in the next couple of years, I could see another bull run ahead.
