It isn't just pensions: Four reasons why Royal Mail shares have failed to deliver

 
Oliver Gill
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Royal Mail Undecided In Further Post Office Closures
Death of a post: letters are in "terminal decline" says analysts (Source: Getty)

Royal Mail's shares fell over five per cent this morning despite delivering in-line trading for the first nine months of the year.

The group's problem is that its core operation – delivering letters in the UK – is shrinking. Add to this pension problems and the potential for industrial action and as Rob Byde, an analyst at Cantor Fitzgerald, summarised: "The investment case is finely balanced with pensions versus valuation."

19 January 2017 @ 9:00amRoyal Mail (RMG)

1 – Terminal decline

The UK business in letters and parcels, which represents around 80 per cent of revenues, is under pressure. In fact, according to Nicholas Hyett, an analyst at Hargreaves Lansdown, it is in "terminal decline".

Letter revenues fell by six per cent once the cash cow of election postage was stripped out and within today's statement, the group revealed their concerns about the future of letters in Britain:

We are seeing the impact of overall business uncertainty in the UK on letter volumes, in particular advertising and business letters.

Although parcel revenues grew by three per cent, that side of the business is coming under "increasing pressure" according to Byde while Hyett added:

The parcels industry looking increasingly crowded. Not only have Amazon taken their operations in-house but Deutsche Post, the big boy of European parcels, has entered the UK through the acquisition of UK Mail.

2 – Pension problems

Recent attention on Royal Mail has focused on the group's huge pension scheme and plans to close it in order to prevent ballooning costs from 2018.

Royal Mail pension statement:
"The member-wide consultation phase will end on 10 March 2017. No decisions will be made until the consultation process is completed, Royal Mail has considered members’ views, and discussed responses with its unions as part of the pension review process. Royal Mail will write to members again once it has made a decision."

Currently there is uncertainty as to how the pension situation will play out. Unions have given themselves enough wiggle room by saying they want input into whatever happens.

The problem for Royal Mail is that it has estimated that keeping its pension scheme open after 2018 will cost the firm over £1bn a year – a cost that would bust the company within a year.

So for now, it is a case of wait and see.

3 – Cutting costs

While recent attention on Royal Mail has focused on the group's huge pension scheme, Royal Mail is also on a large cost-cutting exercise.

The postie said it was "on track to deliver" (yes, Royal Mail's phrase not ours) £225m of cost savings over the full year. The group added it is "confident" cash investment next year can be capped at £500m.

Cutting costs out of the business is, however, only a short-term fix, according to Hyett:

After years spent in public ownership Royal Mail believes it still has plenty of fat to trim, which should help support the bottom line in the near term.

However, cost cuttings can’t continue forever and with much of the low-hanging fruit already gone, arcane topics like the structure of the group’s pension scheme will attract increasing amounts of investor attention.

4 – Overseas sideshow

Royal Mail's overseas business, GLS, performed much stronger, growing revenues by nine per cent and volumes by eight per cent.

The group dipped its toe in the US market by buying Golden State Overnight Delivery Service (GSO) for $90m in October last year. Byde said the historically the US market has been a tough nut to crack given the dominance of FedEx and UPS.

"GLS is continuing to trade well due to strong demand for deferred parcels across Europe, with the exception of Ireland. Recent acquisitions, ASM in Spain and GSO in California, are performing in line with expectations," he said.

The problem is, according to Byde, despite the positive performance of GLS, it only generates a fifth of the group's revenue. This means its positive performance is something of a "sideshow" to the issues facing the wider group.

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