Will Royal Mail declare itself insolvent?

According to newspaper reports, bosses at Royal Mail have threatened to declare the company insolvent if postal strikes are not resolved soon. The courier has neither confirmed nor denied the claims, saying it is doing “all it can” to reach an agreement with the Communication Workers Union (CWU) over pay and conditions.  

As industrial relations remain toxic, however, it is certainly worth exploring the potential implications of administration for International Distributions Services (IDS) shareholders. 

First things first: can Royal Mail actually be placed in special administration? According to the Postal Services Act 2011, the courts can only make a postal administration order if Royal Mail “is unable, or is likely to be unable, to pay its debts” or if it would be “just and equitable” to wind up the company in the public interest. An application for such an order must be made by or with the consent of the secretary of state. 

Here is where we run into some difficulties, however. Can Royal Mail pay its debt? At first glance, the situation doesn’t look good. IDS had £1.47bn of net debt on its balance sheet in September 2022, and Royal Mail expects to report an adjusted operating loss of £350mn-£450mn for the year ended 26 March 2022, and warned that further strikes “would continue to cause losses”. 

However, Royal Mail is just one part of IDS. There’s also General Logistics Systems (GLS), a European courier headquartered in the Netherlands, which is still thriving; in the six months to September 2022, it achieved an adjusted operating profit of £162mn, and provided a lot of the firepower for the 20p dividend announced in May last year. 

In a recent note, UBS analysts said they thought debt had been raised by IDS at a group level rather than a divisional level. This chimes with a comment made by chief financial officer Mick Jeavons in November. When asked about the amount of cash held by Royal Mail compared with GLS, Jeavons said the group doesn’t split up the cash positions in this way, and that finance had been raised at a group level. CWU general secretary Dave Ward said any financial difficulties were “down to the company and the way they’ve dealt with this dispute right from the start”. He said Royal Mail was effectively “threatening the union with administration”. 

But the UBS analysts added that it was unclear whether a declaration of insolvency was feasible at all. Its analysts did say any further industrial action would be an “incremental headwind” for profits in the current financial year, and forecast an operating loss of £151mn for 2024, assuming no further strike action. This is an improvement on the forecast £540mn operating loss in the year just gone. 

Nevertheless, the threat of a wind-down is a powerful one – and could prompt the government to rethink the demands placed on Royal Mail by the universal service obligation. After all, it is not in the government’s interest for the group to become unviable. “At the moment, it doesn’t cost the government a penny to have a universal service and it’s not their problem,” said Liberum analyst Gerald Khoo. 

There is no sign of this yet, however. In November, the government rejected the proposal to end six-day letter deliveries and, in March, the Business, Energy and Industrial Strategy Committee referred the courier to the communications regulator for “deprioritising delivery of letters as a matter of company policy”.

As things stand, therefore, the chances of a group split seem to be growing. IDS said last summer that it would consider separating Royal Mail and GLS unless “significant operational change” was achieved, and now the possibility of insolvency has also been thrown into the mix. As such, equity analysts are trying to figure out what a division would mean for shareholders. 

UBS calculated, for example, that the equity value of Royal Mail was zero, and went on to consider a hypothetical scenario of insolvency/separation. Using peer group analysis and financial year 2024 estimates, and adjusting for debt and leases, it calculated an equity value for GLS of 220- 430p per share, compared with IDS’s current share price of 225p. 

It’s certainly not an exact science, however, and such calculations underline how hard it is to assess the impact of IDS’s debt pile on investors. In a group structure, the distribution borrowings and lease liabilities are often fuzzy. It seems unlikely, though, that profitable GLS will be able to escape entirely unscathed, as shareholders, bondholders and taxpayers battle for the best deal.

Given the threat of administration was followed by a resumption of talks between the CWU and IDS and “some progress”, as per the union, this gambit may have paid off.