Could Royal Mail really fall another 30%?

Having spent the night crunching numbers following yesterday's late warning, Graeme Evans tells us what the analysts think of Royal Mail now. 

Sell recommendations and price downgrades piled up on the doormat of Royal Mail  this morning as City analysts wasted no time in condemning the letters and parcels firm for its Monday afternoon profits warning.

The "kitchen sink" job by new boss Rico Back - cutting the company's annual cost savings target by a whopping 56% to £100 million - left shares 18% lower last night. The pain continued today as the FTSE 100 stock tumbled another 10% to 351p, the lowest level since the 2013 IPO priced shares at 330p.

That's bad news for small shareholders who held on to their 227 shares from the heavily oversubscribed flotation five years ago, or who may have been tempted by the group's 6% dividend yield.

The question for investors now will be whether Back has got all the bad news out the way before stepping up the focus on long overdue productivity gains. Or is there worse to come as the structural decline in letters and margin pressure continue to offset the robust performance in the UK parcels business?

Source: TradingView   Past performance is not a guide to future performance

At least Royal Mail's statement eased immediate fears about the high-yielding divi, which the company said was backed by a strong balance sheet and long-term cash generation.

But having cut his earnings per share target for future years by 38%, Gerald Khoo at Liberum is worried that earnings cover for the dividend is weak. 

He fears that shares have much further to fall, having today cut his price target from 415p to 250p. The mood among other City analysts is not much better, with Goldman Sachs one of the most optimistic at 420p.

UBS analyst Dominic Edridge said the biggest surprise from yesterday's update was that productivity growth was so low at 0.1%, when the company needs to grow by 2% or 3% a year in order to offset cost inflation.

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Royal Mail said the efficiency issues were partly caused by delays to projects in the aftermath of last year's pensions dispute with unions.

Edridge said: "Investor concerns have been focused on GDPR and parcel performance, so this warning on costs is somewhat of a surprise.

"The leverage in the postal business model means any change to revenue or cost flows straight to the bottom line, as we are now seeing."

Edridge added that revenues trends still appeared reasonable, with only letter volumes worse than the company guidance of 4% to 6% after a decline of 7%. This was partly blamed on the negative impact of GDPR, which introduced new Europe-wide rules on how companies collect and process personal information.

Margins at Royal Mail's Europe and North American parcels division GLS have also been hit by a tight labour market. Overall, underlying earnings for the 2018/19 financial year are now expected to be between £500 million and £550 million, compared with the previous consensus at £650 million. In the year to March 2018, the company made £694 million, down from £712 million in 2017.

Shares have now fallen by around 40% from April's peak, completely unwinding the rally from last October's low at around 368p. Royal Mail will be relegated from the FTSE 100 if it fails to recover from this significant sell-off.