The surge in the price of Royal Mail shares since trading began on 11 October has been as spectacular as it’s been controversial. After listing at 330p, Royal Mail shares rose almost 60 per cent to push beyond 530p on Monday, before closing just below 500p yesterday. Retail investors who sold their shares on Monday morning would have booked a healthy profit of over £450 on their initial £750 stake.
But does Royal Mail have much further to rise? Should holders of the shares hang on to them, and might those who missed out consider joining the party?
“Our model values Royal Mail at 599p,” says PJ Davies of Canaccord Genuity, “implying that the stock may have some way to go yet.” Canaccord’s valuation of almost £6bn is far higher than Panmure Gordon’s £4.5bn figure released in the run up to the IPO, and assumes that both sales and people costs grow at 2 per cent for 2014 and 2015. “People costs are a key factor here, given that they are equal to 55 per cent of revenues,” Davies says.
Canaccord’s model highlights the sensitivity of Royal Mail’s profits to changes to the wage bill, adding extra importance to the resolution of the firm’s ongoing labour dispute. “A failure to manage people costs or belligerent union unrest could hit cash flow returns and our valuation materially,” it explains. In this respect, the four-to-one vote in favour of a strike by the Communication Workers Union last week may trouble some investors.
But Robin Byde of Cantor Fitzgerald says the threat of strikes could be seen differently. “I also cover aviation, and it’s not unusual to see stock prices rise after union confrontations – it’s often a sign that management is serious about keeping costs low.” Just as a rise in Royal Mail’s large wage bill could seriously harm profit margins, careful management of this cost would be a huge positive.
According to Gert Zonneveld of Panmure Gordon, however, “the threat of strikes is not necessarily the most pressing issue on investors’ minds. If its competitors grow their share of the end-to-end market, this will be at the expense of Royal Mail,” he says.
The company’s universal service obligation may be problematic in this regard. Royal Mail is mandated to deliver nationwide, regardless of how cost-effective each particular route proves. “If rival firms come in and cherry pick the most lucrative routes, Royal Mail will be at a comparative disadvantage,” says Zonneveld. He points out that regulators would be likely to prevent this from happening, but the uncertainty may unsettle some investors.
A final complicating factor is the stock’s dividend yield in the wake of the current high share price. “It has been indicated that £133m has been set aside for dividends in July,” says Byde, “but the current high share price makes the dividend yield considerably less attractive than it was at 330p.” At the list price, Royal Mail’s implied yield was over 6 per cent, making it one of the most attractive income stocks on the market. But current prices take the implied dividend yield almost as low as 4 per cent. “This is less than popular income stocks such as Vodafone ,” says Byde.