Royal Mail heads for strike

While Royal Mail's current stand-off with its workforce may not be too much of a blow in isolation, it is likely to exacerbate the challenges the company already faces in modernising the business and fending off burgeoning competition, especially in the UK parcel-delivery market. Indeed, rival parcel services such as Parcelhero are readying their services to pick up the slack from Royal Mail’s strike. And even if the strike does not go ahead, many customers could see the mere threat of industrial action as enough reason to put contingencies in place. A key issue here is, once Royal Mail customers have started using rival services there is an increased chance that competitors will continue to take share.

The disruption to services will also make delivering on stated cost-saving initiatives more difficult. The company is aiming to save around £190m of operating costs in the UK parcels and letters division during the 2017-18 financial year, with the aim of bringing total annualised savings to £600m. However, the issues caused by the potential strike action will add to investors' fears that the low hanging fruit for cost savings may already have gone and that future productivity gains may therefore be harder to come by. In total, net cash investment of around £450m is planned for this year.

In Royal Mail's most recent trading update covering the three months to 25 June, revenue rose 1 per cent thanks to 6 per cent underlying growth at Royal Mail's general logistics services – an overseas parcel business accounting for 22 per cent of last year's turnover and 23 per cent of operating profit before restructuring charges. The international operation is seen as having the best potential for growth and management has been focusing on expanding it both organically and through acquisition, including a push into the US. However, this may not be enough to offset weak trading at home.

In the most recent three months, the UK parcels and letters division experienced a 1 per cent fall in turnover. Chief executive Moya Greene called the performance in letters “better than expected” in light of UK uncertainty and a challenging period for domestic businesses. Still, the volume of addressed letters fell by 6 per cent over the quarter and revenue in the division fell 4 per cent, despite the benefit from political party mailings ahead of the general election. There are brighter prospects for the domestic parcels business, but there are also challenges, which means this division may struggle to prop up the ongoing decline in letters. Indeed, while the UK parcel business reported 3 per cent sales growth in the three months, overcapacity in the market and moves by Amazon to take logistics in-house are likely to remain concerns. 

Should trading not live up to expectations, concerns about the sustainability of the progressive dividend policy are likely to grow. Liberum's forecast of declining cover as EPS drops in coming years (see table) suggests this is a risk worth paying attention to.