Four years ago next month Royal Mail began life as a publicly listed company. The flotation of the state-owned postal operator was probably one of the more controversial actions of the old coalition government and became the subject of endless debate over whether the taxpayer had been cheated by its investment banking advisers or had actually secured a rather good deal.
With Royal Mail shares having lost a little over a tenth of their value since the IPO and just over a third peak-to-trough, there seems to be a reasonable case that, at least from a strict investment perspective, the government did not do too badly.
This was further confirmed with this week’s FTSE 100 reshuffle that saw the postal operator relegated, an inevitable outcome given the sustained drop in the shares over the past 12 months.
The question for investors is whether relegation marks a turning point in Royal Mail’s valuation, a subprime entry point perhaps, or whether it remains one to avoid for the time being.
On this count the wise advice would look to be continued caution. The negotiations over the Royal Mail pension plan are continuing and resolution looks about as far away as ever, a point of uncertainty that has played a major part in the stock’s sustained drop. Royal Mail said in April that it would be closing the pension plan next year, saying there was no affordable solution to keeping it open in its current form. It has proposed some reforms but the Communication Workers Union is unhappy with them and has threatened to ballot members on industrial action if the dispute over reforms is not resolved.
The City likes certainty, and the inability to forecast the ultimate pension cheque Royal Mail will have to write makes assessing the company’s valuation difficult. A pay deal with the unions is also still in the works, meaning guesstimating even continuing costs is tricky.
That is all before you look at the long-term structural issues of the postal delivery market and the impact of disruptive competition. Royal Mail’s lead in letter deliveries is unassailable, but then again, no one is trying to steal its crown. Parcel deliveries, by contrast, is a highly competitive market and though the company retains a formidable lead — it handled 53 per cent of UK deliveries in 2015 — the likes of Amazon present a potentially existential challenge at some point.
That said, Royal Mail has several strengths that make it attractive even with its problems. The £420 million of cashflow in 2016-17, up £166 million year-on-year, is one major positive, as is its 23p dividend, up 4 per cent, giving a yield of about 6 per cent.
The company also has an extensive property portfolio that remains available for monetisation. A case in point is its Nine Elms development in London, where it has planning consent to build 1,950 residential units. This week Royal Mail sold its six-acre Mount Pleasant site in north London for £194 million, which has permission to build nearly 700 units.
However, weighed against these advantages are the question of how Royal Mail will cope with what might be termed its human legacy and the fact that by many estimates it is an over-large and under-asset-intensive business. Overcoming these problems, as seen in the union negotiations, will be a significant challenge, particularly in a political climate where a growing section of MPs are fundamentally opposed to it being a private organisation at all, potentially limiting its room for manoeuvre still further. With that in mind, this is one situation where a seat on the sidelines is for now the best place to be.
MY ADVICE Avoid
WHY There is still too much uncertainty over major issues such as pension arrangements and a fresh staff pay deal
Alfa
The boom in car loans is something of a double-edged sword for Alfa, which joins the FTSE 250 today. It provides specialist software used by firms to manage loans for the purchase of assets, such as cars as well as office equipment, aircraft, heavy machinery and satellites. Clients range from Mercedes and Motability, which provides vehicles for people with disabilities, to Barclays and Bank of America.
London-based Alfa is benefiting at present from an upgrade cycle in the asset finance industry, driven by the need to reduce costs and digitalise processes, particularly in the business of motor finance. Three quarters of the total growth in consumer credit since 2012 has been driven by car loans, with nearly 90 per cent of new vehicles sold using finance deals, according to the Bank of England, which is so struck by the rate of growth that it is testing what would happen if a large number of people decided to return their cars at once.
For now this is not a big worry for Alfa. A recent PWC report on the asset finance software market estimates the market is worth about $3.5 billion in 2017 and will grow at an annual rate of 7 per cent for the next three years. True, this is less than the 13 per cent annual growth rates seen from 2010 to 2015. But as a world leader in the field with a strong presence in the US and Europe, Alfa is better placed than most of its competitors to pick up much of this growth.
Shares in the company, which have risen about a third since the company’s May listing, yesterday closed up 5 per cent at 456p after it reported that first-half adjusted profits before tax and interest rose 20 per cent to £21.4 million. Revenue rose 57 per cent to £45 million, including £2 million of non-recurring income from an upgrade project that has been discontinued.
Of the five late-stage deals at the time of its float, two have converted and two more, described as “very material”, remain in negotiation. A further two have entered this stage and the company has boosted staff numbers from 268 to 300 in anticipation of a strong second half, adding that it foresees “a strong and diverse pipeline of opportunities”.
MY ADVICE Hold
WHY Premium product with a long pipeline of customers
