But comments made by Britain’s oldest postal institution gave rise to investor concern sparking a 6% slide in the share price.
Concerns centre on market competition, regulatory issues and the future growth of the dividend. The Royal Mail is facing stiff competition in parcel services from the likes of UK Mail, DPD Hermes, and Amazon Logistics Service, not to mention TNT Post who recently launched a complaint against the Royal Mail. The latter led to an investigation by Ofcom last month. Meanwhile the dividend could be in danger of being downgraded should these headwinds knock investor confidence.
Competitive forces
The UK enjoys one of the highest levels of postal freedom ranking as number two in the world, according to the Postal Freedom Index.
This freedom is creating a challenging environment for the UK’s oldest postal service. On Wednesday it announced a trial delivering parcels on Sundays, as well as offering a one-hour delivery service. But growth in parcel delivery is slowing down as numerous competitors step into the UK parcel business. Both DPD Hermes and TNT Post are planning on expanding their businesses in this area, with TNT Post also looking at letter deliveries.
“For the first time in its history, Royal Mail made more money from delivering parcels than letters. Letter volumes fell by 4%, at the lower end of the expected 4% to 6% range. However, growth in its parcels business was 7% compared with City expectations of about 8%,” according to Garry White, chief investment commentator at Charles Stanley Direct.
Regulation headwinds
The UK’s second largest mail service, TNT Post, launched a complaint against Royal Mail leading to an investigation by Ofcom in April. The dispute is on breaches of service contracts and area access between the two companies.
While the Royal Mail sees its universal service obligation under threat, TNT is thinking of expanding. TNT wants to expand 42% in the UK but only in populated areas such as London, Manchester and Liverpool. Meanwhile Royal Mail is unable to pick and choose as it has a mandate to deliver six days a week all over the UK.
AS a result of this pressure Royal Mail said that based on its estimates of the impact of TNT Post UK's publicly-stated plans, direct delivery could reduce Royal Mail revenue by over £200m in 2017-18.
The dividend
So what does the current state of play mean for investors looking at the company’s future growth?
“No dividend is safe,” according to White.
“The Royal Mail’s cash flow is looking quite good so I’m not worried at the moment But the regulatory issues need to be sorted.”
In its statement, the company said that it would wait to see the outcome of the TNT story before giving further clues on its dividend.
“The company’s statement is a negative sign for me,” according to Nicla Di Palma, equity analyst at Brewin Dolphin.
“For the time being the company is still advocating a progressive dividend. If I had to bet, I would say there could be a dividend downgrade in the next years,” she added.
This sentiment was shared by Gavin Oldham, CEO of the Share Centre.
“Management continues to focus on cost cutting and improving company performance, however the increasing competition raises concerns. As a result, the company’s growth prospects in the short to medium term have been questioned. This, alongside the current share price valuation, means we continue to recommend investors ‘hold’ Royal Mail,” he said.
Meanwhile Stuart Welch, CEO of TD Direct Investing, noted a change in investor interest among customers.
“Our data shows that in April 2014, 53% of all our Royal Mail trading was sells, whilst 47% related to investors buying the stock. This is a real contrast with the initial frenzied activity last October, when 82% of Royal Mail trades were sales of shares, with just 18% being buys.”
Investor outlook
Clearly the Royal Mail is facing challenges in its service environment. There are positives too, as the company has performed well and has accumulated a profit since launching. Depending on how the regulatory issues are sorted, the Royal Mail could get an edge in the market. However investors are cautious on how the dividend will perform in the months ahead. While the outlook is not significantly negative, there are risks ahead for potential downgrades.
