At face value, the collapse of City Link on Christmas Eve is just the latest in a long line of setbacks for the UK's postal and courier services as they struggle to get to grips with the online retail revolution. The ever-changing dynamics of consumer spending have caused significant upheaval for the sector, and intense competition between niche parcel businesses is just one unwelcome side-effect. This has been particularly detrimental for the UK's national courier Royal Mail (RMG). As the popularity of online shopping grows, so does the need for specialist parcel carriers that can meet the demands of Britain's customers who want their goods the next day - if not the same day - as 'Amazon-isation' sweeps the industry.
While the niche parcel carriers duke it out for new business contracts, Royal Mail is suffering. The nation's best-known postal service was controversially privatised towards the end of 2013. The shares floated at 330p. Since then, the share price has rocketed to a high of 618p before slowly coming under pressure. The share price has subsequently dwindled to 419p, reflecting a flurry of trading woes for the group.
Although Royal Mail's letters division is faring well, this was disproportionately boosted by the timing of local elections and a subsequent surge in postal votes. And the parcels division has reported a 1 per cent squeeze in revenues despite a 2 per cent improvement in volumes. Chief executive Moya Green cited growing competition as the culprit behind Royal Mail's woes - in particular Amazon's (US: AMZ) decision to take direct control of its delivery network. Royal Mail has also been plagued by tensions with staff unions, tight cost control and an £18m provision regarding a settlement with the French competition authority. We advised investors to offload the shares at 565p. Since then, the share price has fallen by 26 per cent.
In the run-up to Christmas, record amounts were spent online. But the now-defunct City Link was already in the doldrums. It was bought for just £1 by turnaround specialist Better Capital last year. But even it struggled to successfully reposition City Link in a sector suffering from severe overcapacity in a low-wage economy. It's estimated that retailers can take their pick from roughly 10 delivery companies all competing for their business, while some online behemoths such as Amazon have removed competition from the marketplace completely by taking their delivery business in-house. This has prompted a severe price war as couriers slash rates to win new contracts and edge out their rivals.
Before Christmas Eve approximately 2,700 people were employed by City Link. Now, after a wave of redundancies announced on New Year's Eve and the first few weeks of January, only 141 employees will be left. It also has 20,000 undelivered parcels on its books. They will be sent to a base in Coventry where customers can collect their goods or wait for delivery by another firm.
There is, however, a winner from the City Link collapse: recently-listed DX Group (DX.). DX will pay just over £1m for various City Link assets, including equipment and intellectual property rights. Although DX shares came under pressure as sentiment towards the sector suffered last year, the company still offers investors a cheaper opportunity than its closest competitors Royal Mail and UK Mail (UKM). The latter two are still heavily reliant on letter delivery, which makes up half of group revenues. But this is not the case at DX. Only a quarter of revenue comes from letters and its niche offering of 'document exchange' services sets it apart from the competition.
According to researchers at Edison, the parcels market managed to grow through the recession and should still deliver growth of around 3.8 per cent a year for the next five years. That should deliver a helpful tailwind for DX, particularly as it specialises in outsized deliveries and freight services. There are other signs of growth in DX's business: its logistics division is currently the smallest business unit, but it still managed to increase revenues by 35 per cent last year to £32.3m.
While UK Mail doesn't have the niche appeal of DX Group, it also isn't lumbered with the onerous task of delivering the nation's mail - often across several unprofitable postcodes. Speaking to chief executive Guy Buswell in November, when the company reported six-month results, he admitted the group suffered a tricky first half. A dip in e-commerce spending led to a worse-than-expected second quarter for the group's parcel division, which makes up 45 per cent of total revenues. But Mr Buswell previously stated he was confident Christmas shopping trends would boost third-quarter figures. On 13 January, his prediction came to pass with confirmation that the parcels division ended up handling record volumes over the festive season. Meanwhile, its traditional letters business is stealing market share: daily mail volumes rose 2 per cent in the first half of the financial year, even as industry volumes fell by about 3 per cent a year.
Like its competitors, shares in UK Mail underperformed last year. But this de-rating gives would-be investors a second bite at the cherry, especially when the shares trade on an undemanding forward PE ratio of 13 and yield close to 5 per cent.
IC view: Overcapacity has gripped the mail and courier sector, and intense competition has led to casualties including City Link. It's an industry in rapid transition, but with the seemingly irresistible rise of e-commerce, there’s unbridled potential for expansion. The reality is, however, that an overcrowded marketplace is not sustainable - others will fall by the wayside. Growth remains elusive for a number of companies as they go head to head to win new business. Concentrating on niche services will serve as a lifeline for some parcel delivery companies, while traditional businesses are set to suffer for the foreseeable future (short of regulatory reforms). In the meantime, Royal Mail will have to work hard to reverse investor sentiment after a poor 2014.
