Royal Mail shareholders toast dividend decision as shares fly

After hitting an eight-month share price low in October, parcel deliveries are leaving their stamp and the stock is fast recovering lost ground.

Even though the positive effects of the pandemic on parcel deliveries are subsiding, the tailwind from the switch to online shopping increasingly looks like it is here to stay.

Domestic parcel volumes are 33% higher than pre-pandemic levels and international GLS business volumes have risen by 30%. Compared to last year’s spike, the figures are more pedestrian over this period, with a decline of 4% in domestic and an increase of 8% for GLS. 

Even so, Royal Mail (LSE:RMG) is positioning itself for a new environment in which parcel deliveries are leaving their stamp.

Apart from innovations such as the introduction of Sunday deliveries and “Parcel Collect”, both designed to capture the additional business at the expense of its competitors, the group is driving the dual and powerful benefits of continued investment in the business alongside efficiency savings. 

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An increasingly automated service behind the scenes will leave scope for further capacity increases, and the strength of future cashflows from both Royal Mail and GLS are expected to be sufficient to cover further investments. This level of self-funding will therefore ease pressure elsewhere on the balance sheet and, in the meantime, the group is reaping the benefits of higher volumes.

Revenues rose by 7.1% in the half-year, operating margin increased strongly from 0.7% to 6.7% and net debt saw a significant reduction from £1 billion to £540 million. At the same time, cash flow increased by 36% and net cash rose, all of which combined to produce a pre-tax profit of £315 million, as compared to £17 million in the corresponding period last year.

The cash excess has also enabled the payment of a special dividend as well as a share buyback programme which total £400 million. With a projected dividend yield of around 4.5%, investors have seen the dual benefit of share price appreciation while being handsomely paid to wait as the group’s transformation unfolds.

The adjusted operating profit outlook for the year as a whole is now £500 million. There are inflationary pressures at play, with the likes of a reduction in air freight capacity and increased customs processing threatening to upset the cost balance. 

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The staffing issue is less pressing, since Royal Mail not only has a largely permanent workforce, but also has a pay agreement in place which should mitigate the immediate inflationary clouds. At the same time, the group is targeting further efficiency savings which will hopefully keep additional costs to a minimum.

Even so, there are some pressures to follow, such as the increase in National Insurance contributions and the unwinding of its fuel and energy hedges. There are also some tough comparatives to follow in the second half, which will crimp some of the boost seen in revenues in the year to date.

Royal Mail has been another beneficiary of enforced strategic acceleration resulting from the pandemic. It is currently skilfully spinning a number of plates as it continues to transform, and the share price has reflected this progress, having risen by 55% over the last year as compared to a gain of 14% for the wider FTSE100. 

It would therefore be with some irony that, at current levels, the company is on the cusp of relegation at next month’s FTSE100 reshuffle as a result of recent share price weakness which has seen a dip of 16% over the last six months. 

However, bulls of the Royal Mail story are not to be deterred, with the market consensus of the shares as a "buy" remaining defiantly intact.