Royal Mail (LSE:RMG) shares tanked on Wednesday, extending losses for the year. The stock was trading for more than 500p this time last year. Today, it is trading around 268p, down 47% over 12 months.
So what’s behind Royal Mail’s slump, and does this represent a buying opportunity for my portfolio?
What’s behind the falling share price?
There are long-term trends behind the falling share price, as well as more current issues. Firstly, there is the decline in letter usage. The volume of letters posted has fallen by more than 60% since its peak in 2004-05. Letter volume is down 20% since the start of the pandemic too.
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There are also inflation issues. Sky-high numbers are causing customers to cut back on the volume of letters and parcels sent as well as orders made online. But it’s also pushing up wage costs. Labour is the group’s biggest cost and Royal Mail is currently embroiled in a staff crisis over job cuts, pay, and working conditions.
Earnings update
On Wednesday, the company said that revenues had sunk 11.5% year-on-year during the first quarter of its trading year, noting this reflected weakening retail trends, lower Covid-19 test kit volumes, and a return to a structural decline in letters.
Then there is a “disappointing performance” in terms of delivering further efficiencies, with the Royal Mail reporting an adjusted operating loss of £92m, primarily because of the “inflexibility” in its cost base to adjust to lower volumes.
However, it suggested that operating profit in its UK business will break-even for the full year, unless industrial action further impacted margins.
On a brighter note, Royal Mail said its Netherlands-based parcel service GLS expects year-on-year revenue growth in the high single-digits, with full-year operating profits between €370m to €410m.
Outlook
Royal Mail is a company in transition. And there are two major movements: from letters to higher margin parcels, and mechanisation. Firstly, the pandemic provided Royal Mail with the chance to speed up its transition to parcels, and this has happened. This should help the group transform its revenue going forward due to higher margins on larger packages.
Moreover, prior to the pandemic, the majority of parcels being processed were being sorted by hand. Clearly that’s a costly and time-consuming process. But now, that number is closer to 50% and this should help the business become leaner.
There are obvious challenges as mentioned above. An economic downturn combined with inflation isn’t going to be good for business.
Would I buy Royal Mail shares?
Royal Mail looks like a good long-term buy for my portfolio. However, I appreciate the risks of buying shares in a business which is very much in transition and facing some pretty sizeable issues.
For me, now might well be the right time to buy, with the firm trading with a price-to-earnings ratio of just 4.7.
