Share in Focus: Royal Mail

This week, on the 22nd May, we will see Royal Mail announce their full year results 2018-19. Royal mail has for 1 year done not much else but decline from a high of 561p to a year low of 231p. We will now examine the company as a whole, the reasons we are where we are and what may be in the future, assessing the case for investment.

Overview of Royal Mail Shares

Royal Mail is a postal service and courier company in the United Kingdom, originally established in 1516. The company's subsidiary, Royal Mail Group Limited, operates the brands Royal Mail (letters) and Parcelforce Worldwide (parcels). Royal Mail has had a wide and varied history throughout the years: it was once part of BT and the demerger between the two organisations occurred during the 1980s. In modern times Royal Mail has struggled with falling demands for services and competition that has entered the market. Since 2006 Royal Mail lost its 350-year monopoly and the British postal market became fully open to competition.

In 2008, due to a continuing fall in mail volumes, the government commissioned an independent review of the postal services sector by Richard Hooper CBE, the former deputy chairman of Ofcom. The outcome was the recommendation of Royal Mail to be part-privatised, but due to strong Labour opposition this plan was scrapped.

In 2013 the government announced the IPO of Royal Mail shares, which ended up in an oversubscribed offer that had to be scaled back.

On 4 June 2015 the Chancellor of the Exchequer, George Osborne, announced the government would sell its remaining 30% stake. A 15% stake was subsequently sold to investors on 11 June 2015, raising £750m, with a further 1% passed to the company's employees. The government completed the disposal of its shareholding on 12 October 2015, when a 13% stake was sold for £591m and another 1% was given to employees. In total the government raised £3.3bn from the full privatisation of Royal Mail.

Royal Mail currently sits at an all time low with many speculating a dividend cut could be on the cards. The dividend currently sits at 10% which is clearly quite high. The results that are due to be announced will highlight the company’s performance for the financial year and whether the management have lived up to the expectations. The trading update released on the 29th January this year states that the company “expects to deliver adjusted Group operating profit before transformation costs of £500-530m for 2018-19”.

The half year results were not so great, with adjusted operating profit margin, after transformation costs, of 3.9 per cent, down 150 basis points. The adjusted profit before tax of £183 million, which was down 27 per cent on an underlying basis, was largely reflecting the operational performance.

The full year is targeting a 6% margin for the year which, so far, is well off from the half year results as shown above. For this to occur significantly, higher margins would have to be achieved in this second part of the year.

£100 million of cost savings can only go so far and the company intends to keep its progressive dividend policy and all short interest are pinning their hopes on a dividend cut and results falling short of expectations.

If we believe the market has priced in the bad news with Royal Mail, as Berenberg states, we could get a muted sell off or possible flat share price performance on the day. The best-case scenario would be Royal Mail keeping their dividend intact and operating profit margins falling into the higher than expected range towards 550million.

An unexpected benefit of this would be a short closing effect that would cause a possible short squeeze on the stock, giving rise to a large up move in the share price.

As we can see nearly 5% of the Royal Mail stock is sold short via hedge funds, the moves recently indicate a slight reduction in short exposure but on the whole there is a net increase effect for the month of May.

If shorters are correct and the company posts worse than expected figures, there will be a sell off which inevitably could see Royal Mail hitting new lows.

For any long term share holders of Royal Mail that wish to mitigate the effect of a fall in share price, you can with some brokers request for your shares to not be lent out for short sale. Another way to do this would be to place a price target much higher than the current price (i.e. £4share), your broker will not want to take the counterparty risk by lending the shares out to short sellers in case this price hits.

The long-term risks of Royal Mail are a possible nationalisation by a Labour government, dependant on the prevailingshare price newer holders may even profit from such a move.

Either way whatever occurs on the 22 May, we believe Royal Mail to be a British institution that is not about to disappear any time soon.

Click to download Share in Focus: Royal Mail Report.