Think about the UK's most important recent infrastructure projects and the word 'Hinckley' and the image of a nuclear reactor probably spring to mind. Such a link, while forgivable, betrays some poor spelling. Hinkley Point may be by the sea, but it is without a 'c' (and possibly power station 'C', if the Chinese-backed project is blocked). Hinckley, meanwhile, is the Leicestershire town that last year became the home of Europe's largest automated parcel sorting facility. Operated by DPD - the carrier owned by La Poste, France's state-backed equivalent of Royal Mail (RMG) - the £100m development can process 720,000 parcels a night.
Logistics, sorting offices and night-shifts - it's hardly on a par with high-level diplomatic stand-offs and nuclear energy policy. But DPD's Hinckley site is a useful example of the arms race currently engulfing the super-competitive postal services sector; a dull-sounding investment that belies the major economic shifts it's connected to. That's because, while email and mobile is killing off letter sending at a predictable pace, parcels are a staggering growth market, largely thanks to the 10-15 per cent expected annual uplift in online retail sales in the UK between now and 2020. Figures bear this out: the Office for National Statistics reckons average weekly spending online was £945m in June, an increase of 14.1 per cent on the same month a year ago. All of this requires mail services, hence investments like Hinckley or Hermes' new £31m hub in Warwickshire.
The growth in online retail
Theoretically, this should make the sector a great investment, but hoovering up chunks of this growing market is hardly straightforward. Take mid-tier player UK Mail (UKM), formerly known as Business Post. Last year, it was beset by problems with its transport network and a new sorting hub in the West Midlands, which proved incapable of handling oddly sized mail items. For an industry increasingly focused on rapid, premium delivery services, UK Mail's failure to get the basics right was painful.
Despite possessing an unrivalled postal distribution network in the UK, Royal Mail is also playing catch-up with the country's changing postal habits. In the year to March 2016, it spent £72m on regional distribution centres for tracked products and next-day parcel collection services, representing a 31 per cent year-on-year increase in project costs, and in May launched free standard parcel delivery confirmation on all packages in a bid to placate and win over small online traders.
The reason for the push is not just about market opportunities, but one specific market threat: Amazon (US:AMZN). If there's one lesson from the US company's first two decades, it's that it seeks to conquer, and destroy if it must. Long a dominant force in e-commerce, in the last couple of years Amazon has been quietly amassing its own end-to-end distribution network, Amazon Logistics. According to various market reports, the service now handles as much as 80 per cent of the sales generated by amazon.co.uk, which happens to be the country's largest online retailer, although it's also marketed to third-party retailers who are encouraged to use Amazon's marketplace and logistical firepower.
Royal Mail, like DPD and the rest of the competition, carries some of the delivery volumes generated by Amazon. But now it must expect to relinquish that share, and concentrate on winning big delivery contracts elsewhere. Last year, volumes lost to the US e-commerce giant were offset by new deals signed with John Lewis, Marks and Spencer (MKS) and Waterstones, although chief executive Moya Greene acknowledges that future share of the parcels market is dependent on how aggressively its largest competitor expands.
Royal Mail is not the only national incumbent to feel the Amazonian heat. Until now, Germany's position as Amazon's second-largest market was great news for DHL Express owner Deutsche Post (DPW), but the wolf is now at the door. Since the US group launched a pilot delivery project in Munich last October, DHL has lost nearly a third of its share of the Bavarian capital's parcels market. Outside Germany, DHL and other continental carriers are likely to face further pain from Amazon's network of European 'fulfilment centres', which the online giant believes can beat the competition on shipping times and lower delivery costs.
One potential counter-threat could come from the looming arrival of the sharing economy in this space, which is more or less guaranteed to eventually eat into higher-margin superfast delivery services typified by Amazon Prime. UberRUSH - the taxi-hailing app's foray into logistics - is not yet available in UK cities, but traditional carriers will no doubt be watching over their shoulders to see how technology could disrupt the market further.
| Name | EPIC | Mkt Cap | Price | Fwd PE | DY | EV/EBIT | EV/Sales | EBIT | Cash Conv. |
|---|---|---|---|---|---|---|---|---|---|
| Royal Mail | RMG | £5.1bn | 510p | 12 | 4.3% | 9 | 0.6 | £598.0m | 122% |
| UK Mail | UKM | £170m | 309p | 14 | 5.3% | 15 | 0.3 | £11.2m | 260% |
| DX Group | DX. | £30m | 15p | 3 | 33.9% | 2 | 0.1 | £16.6m | 117% |
| Deutsche Post | DPW | €32.5bn | 2,680¢ | 14 | 2.5% | 20 | 0.6 | €1,825m | 173% |
| PostNL | PNL | €1.52bn | 344¢ | 8 | - | 6 | 0.6 | €333m | 48% |
| bPost | BPOST | €4.69bn | 2,343¢ | 14 | 4.4% | 8 | 1.6 | €486m | 69% |
IC VIEW:
A steely focus on price allowed Amazon to dominate the first market it created. It was only able to do that on the back of long-established parcel delivery networks, but the company now wants to control the entire process. For all the talk of the 'Uberification' of the delivery marketplace, the US behemoth can already lay claim to possessing the killer app, an incredibly popular platform for retailers to sell their products through, and an advanced logistics network to smooth the delivery process.
Of course, online retail doesn't stop at Amazon, and that means there will be space for the likes of Royal Mail, Deutsche Post or Belgian carrier bPost (BPOST), and even the mid-tier operators which can focus entirely on parcel delivery. But Amazon's capacity for dogged investment and brutal efficiency is certain to make the rest of the market's lives difficult for some time.
Favourites
It may only handle a minority of total UK deliveries, but Amazon's market position shouldn't be underestimated. Consider the company's advantages: unlike Royal Mail, it reinvests free cash back into its delivery network and is the global name in supply chain automation. Unencumbered by the expectation of a dividend, and starting with a comparatively low market share, it's hard to see the e-commerce giant failing to increase earnings.
One company that should reap rewards from the logistics sector no matter what happens is Tritax Big Box REIT (BBOX). The property group, which predominantly focuses on the distribution centres of large retailers, also owns and leases facilities belonging to DHL in Nottinghamshire and Lancashire. Key to the Tritax investment case is the weak supply in large warehouses in the UK, which the company has been adept at capturing in off-market deals. Expect the company to be well placed to benefit from the numerous players wanting to build facilities like DPD's sorting office at Hinckley.
Outsiders
Last November, DX Group (DX.) saw its share price plummet 70 per cent on a single profit warning. Not only did volumes at its secure document delivery service erode at a faster rate than expected, but DX couldn't find enough drivers, and was weighed down by historic, low-margin contracts. The shares currently trade at such a discount to its peers it suggests the market has lost confidence altogether.
Despite the aforementioned problems with its automated hub and the two profit warnings that followed, UK Mail appears to be winning back some of the market's confidence. The group has done well to hold on to a number of key customers, remains debt-free and should see an improvement in margins.
