Royal Mail’s surprise windfall shows confidence but some hurdles still remain

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Royal Mail PLC (LSE:RMG)‘s surprise GBP400mln shareholder windfall indicates the directors are confident that the pandemic-fuelled turnaround of the group is here to stay.


Analysts, while wary about some factors such as cost pressures proving persistent, are also cautiously optimistic too.


The FTSE 100 group announced the payout this morning – in the form of an interim dividend of 6.7p a share, a GBP200mln special dividend and the immediate launch of GBP200mln share buyback – alongside half-year adjusted operating profits that were ahead of City expectations.


With a cash position at the half-year standing at GBP685mln, management said they believe it is appropriate to move towards a net nil cash position in two years.


Analysts at UBS said: “This implies that post the shareholder returns announced today, the company will likely be left with further firepower for organic investments, bolt on M&A or further cash returns to shareholders.”


READ: New Royal Mail boss has chance to push the envelope


The turnaround has undeniably been helped by the UK coronavirus lockdowns that prompted a huge shift to online shopping and all the parcel deliveries that requires, but management are attributed some credit in the City for the previous restructuring and, as commentator Neil Wilson at Markets.com puts it, “largely getting the union monkey off its back have helped, too”.


Increased automation is a large part of the restructuring, along with the introduction of Sunday deliveries and the doorstep Parcel Collect service, with the latter two designed to capture the additional business at the expense of its competitors.


Automation of parcel sorting has risen to 50% of the total from 12% in 2018-19, with ambitions for the share to reach 70% in the coming year.


“Automated parcel sorting is more cost effective, but also improves quality and provides the extra flex needed to deal with peaks and troughs in demand,” says Nicholas Hyett at Hargreaves Lansdown.


As ever, one or two good years does not a consistent company make, with the second half of the financial year requiring further demonstration of the group’s long term potential.


As Hyett says, year-on-year revenue growth will get more challenging as the group laps last year’s lockdowm Christmas.


What’s more, Royal Mail flagged up productivity and quality issues, with the business “currently facing challenges with higher than expected sick absence and level of vacancies…the bedding-in of the significant change from the recently deployed revisions”.


As a result, it revised down its productivity improvement cost reduction target to GBP80mln from GBP100mln.This and the timing of achieving an agreement with the unions on the wag, raised a red flag for UBS on the cost savings targets for the next full year.


“For the UK division the company indicates a few elements of inflationary pressure, but also circa GBP190m of cost savings identified so far. The slow start on the productivity improvements this year leave some risk to fully achieving these costs savings we believe,” said the Swiss bank, maintaining its ‘neutral’ rating and 440p price target.


Similarly, Gerald Khoo at broker Liberum said while the initiatives on costs and productivity in the UK are making progress, they face “strengthening headwinds” from wage inflation and energy costs, with similar pressures at GLS “make its margin target harder to achieve”.


Liberum kept its ‘hold’ stance and 560p target.


Analysts at Peel Hunt were more optimistic, saying the group is maintaining its targets and see it as “significantly undervalued” relative to its European peers, leading to a reiteration of its ‘buy’ recommendation at 625p price target.

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