Historically, UK investors have had few options to benefit from the steady, utility-like earnings stream on offer from the mail and parcel delivery sector. But that is all set to change later this year as one of the last bastions of the public sector, the Royal Mail, rumbles towards a landmark privatisation. And it is not only the Royal Mail's potential listing that should make investors pause and take a second look. The internet has created strong, long-term structural growth forces for parcel businesses as shopping migrates online. We've taken a closer look at a range of investment opportunities from across the globe in the mail and couriers sub-sector.
Return to sender
The story of Royal Mail and its recent turnaround has improved the outlook for the mail and parcel delivery sector as a whole. For years the Royal Mail struggled under the weight of revenue controls and legacy costs. When mail volumes started to decline with the advent of email and e-documents, the Royal Mail was hit hard due to high fixed costs and a commitment to maintain the service. Unlike many private sector operators who were quick to wield the axe, the well-organised communication workers union (CWU) ensured the job security of its members. As a result, Royal Mail has suffered yawning losses over the past five years.
But all that changed in April 2012 as the group was largely freed from revenue controls and stamp price increases were allowed. Meanwhile the internet, which has often been billed as highly instrumental in Royal Mail's demise, is powering one of the fastest-growing areas for the industry - that of parcels. The increasing number of goods purchased online has been a boon for the postal industry. E-commerce shows little sign of slowing, and the pain felt on Britain's high street should lead to further gains in the postal business.
The Royal Mail's fortunes have been transformed. In the results for the half-year to the end of September 2012, the group delivered around 58m items a day in the UK and the core UK Parcels, International and Letters (UKPIL) business, which is responsible for 83 per cent of revenues, reported a turnaround from a £41m loss to a £99m operating profit. The driving force behind this performance was stamp price increases offsetting the decline in letters. But there was also encouraging growth in the parcels operation as volumes were ahead 4.2 per cent to 673m items. Overall, the group reported profits jumping from £12m to £144m after adjusting for costs under the modernisation programme. This profit wasn't just a figment of accounting, either, cash inflow at the business was strong at £218m.
When the Royal Mail comes to the market - as is both the group's and the government's preferred option - it will offer investors an intriguing prospect. Momentum is building after a major hurdle - the group's crippling pension liability - was cleared when the European Commission allowed the government to take on some £37.5bn in liabilities, offset by £28bn in assets.
The listing would be one of the most important developments since the Royal Mail's foundation in 1516 when Henry VIII established the "Master of the Posts". The royal moniker is thought to have saved it from the first wave of privatisation under Thatcher, but there seems to be little to hold it back this time round with a government desperate for the potential windfall. World stock markets have been soaring to record highs and the only other listed letter and parcel delivery business, UK Mail, provides an instructive glimpse into market conditions.
Santa's little internet helper
As consumers increasingly migrate online it has created strong growth dynamics for parcel delivery businesses. The only listed pure play on mail logistics, UK Mail, recently updated the market on trading over its crucial festive period, from 1 October to 31 December, and volumes of parcels were up 20 per cent. This bodes well for final results, as at the half year parcel revenues were some £87.2m of the £226m group total. UK Mail is also bucking the trend of declining letter volumes, with mail operations, responsible for 51 per cent of group revenues, increasing volumes by 2 per cent, against a wider UK market that saw a 5 per cent decline. All this meant underlying revenues at UK Mail were up 8 per cent and ahead of market expectations. Broker Investec upgraded forecasts for adjusted EPS by 6 per cent to 22.7p.
The growth in parcel volumes has significantly changed the dynamics of the mail logistics business. From a sector suffering from flat or falling growth it is now characterised by manageable decline in mail operations, with profitable growth opportunities in parcel delivery. Shares in UK Mail have soared by over 90 per cent from lows of around 190p in late 2011, to record highs of 380p. What's more, at that price the shares yield 4.8 per cent, although the rating has crept up to a punchy 16.7 times adjusted forecast earnings per share.
Global outlook
Globally, there are many different ways into the mail logistics sector. The dynamics that are playing out in the UK market are being replicated across the world. A manageable decline in letter mail volumes of between 2 to 4 per cent in Europe is being offset by rising parcel volumes driven by online trade. Deutsche Post DHL is the perfect combination of the two themes following the merger of the German postal operator with the American courier. Deutsche is keeping a keen eye on costs which has stabilised earnings in the core business while the global parcel and freight expert DHL is expected to deliver double-digit earnings growth.
The two big US operators, Fedex and UPS, are often seen by investors as barometers of the state of the US and wider world economy, given that they handle correspondence and goods between business. Worryingly, Fedex recently sounded a warning over Asian economies as it updated the market on trading in the quarter to 28 February. Fred Smith, chief executive, told the Financial Times, the company had experienced "very challenging" conditions, with net income down 31 per cent on last year to $361m, on revenue up 4 per cent to $11bn. He went on to add that flights between North America and Asia would be reduced from 1 April. Mr Smith said the tough trading situation has been made worse by significant new capacity coming into the international air freight market.
IC VIEW:
The postal and express package delivery industry is a highly-cyclical sector which means shareholder returns are closely linked to the global economy. Cost-cutting and restructuring delivered excellent share performance from 2009 but now there are clearly concerns around Asian growth and overcapacity in the market. However, if the US economy can continue to surprise through its resilience, then companies with greater exposure there will benefit.
The Royal Mail float, if it happens as expected in the third quarter, will also be worth a look when investors get a better idea of pricing and any potential dividend. With revenues now free from controls and a huge share of the market, it could provide a steady income.
