Over the past 12 months, I’ve recommended Royal Mail (LSE: RMG) shares on several occasions. I think the company’s fortunes have changed entirely since this time last year.
Surging parcel delivery volumes have helped the company outperform expectations. And as profitability has jumped, the corporation has set aside more cash to reinvest back into the business. I think this is the right decision.
However, as the company ploughs profits back into its operations, shareholders could be left wanting. Indeed, under management’s new dividend policy, Royal Mail shares will only offer a modest level of income.
What’s in store for Royal Mail shares?
Over the past few years, the company has struggled due to a lack of investment. Falling profits have restricted spending plans, which means management hasn’t been able to invest in the business.
This left the enterprise woefully underprepared for the future. Management is now planning to rectify this error. Last year, the company announced it would construct two fully automated sorting facilities in the North West of England. On top of this, management is also planning significant investments in automation across the rest of its network.
Unfortunately, this won’t come cheap. Planned capital spending will be “well above” £400m in the current financial year. Meanwhile, the group is also investing £160m in its international arm, GLS.
This spending is essential, but it does mean the firm can’t afford to pay significant dividends to investors.
In the current year, the company is planning to pay out 20p per share for the financial year. At the current share price of 590p, Royal Mail shares offer a dividend yield of 3.4%. Long gone are the days when the stock used to provide a yield of more than 5%.
Management has said the company will adopt a “sustainable progressive dividend policy” in the years ahead. Still, I reckon that as long as capital spending remains high, there won’t be a significant increase in the payout.
Buy or sell?
So, after taking all of the above into account, should I buy Royal Mail shares at 590p? This is a difficult question to answer.
On the one hand, it looks as if the stock is firing on all cylinders. On the other, it’s difficult to tell if last year’s growth was just a one-off boost, or if the higher demand for parcel shipments is here to stay.
I think the answer to this question is somewhere in the middle. Shipments may remain elevated, but I don’t think they will stay at pandemic levels.
Still, if parcel delivery volumes continue to increase, the company’s spending initiatives may pay off. In this scenario, Royal Mail’s sales and profits could continue to expand.
Therefore, I think, on balance, the risks of owning Royal Mail shares outweigh the potential for reward. The company is spending heavily to modernise its operations, but there’s a chance this spending may not yield results. And if profits start to slide, the stock could fall back as well.
