Even without the decline of its letter business and growing competition from more nimble delivery outfits with warehouses run by robots, Royal Mail is in serious trouble. Its earnings outlook and valuation remain heavily dependent on the outcome of labour negotiations and that represents a serious risk to the shares.
Although it recently won a court ruling to stop a strike before Christmas over proposed changes to workers’ pensions, Royal Mail remains under the cloud of threatened industrial action until mediation talks can be completed. The company maintains that its proposed reforms, which would allow employees to choose between a new defined benefit scheme or a defined contribution scheme, should help curb its ballooning deficit.
Without reform, it warns, the cost of keeping the pension scheme unaltered means a bill of more than £1 billion within a year, probably a lot more.
The company is also heading for a showdown with its workforce over pay, having assumed a 1.5 to 1.9 per cent increase in wages next year, while the Communication Workers Union (CWU) is demanding 5 per cent. Assuming wage inflation of 2.1 per cent, analysts at Jefferies have arrived at a fair value of 320p per share, well below yesterday’s price of 395½p. But if Royal Mail ends up with wage inflation of 3 per cent, that would reduce the analysts’ fair value to 150p, other things being equal.
In this light, the company’s statement yesterday that this is a “difficult time for Royal Mail and its people” seems a colossal understatement. Last month Terry Pullinger, deputy general secretary of the CWU, said he’d rather “smash Royal Mail to bits” than back down in the pensions dispute.
Despite this, the company yesterday insisted it remains committed to resolving key issues with the union, adding that it is proud to provide the best pay and terms and conditions in the sector.
The real problem, however, is that its competitors are not subject to the same unionised wrecking ball that Mr Pullinger is threatening to swing its way.
Away from its industrial relations mess, Royal Mail results look decidedly mixed. Revenues in the six months to the end of September rose 5.4 per cent to £4.8 billion and pre-tax profits fell 30 per cent to £77 million, largely because of a £114 million increase in pension costs.
Within the UK Parcels, International and Letters business, letter revenues declined 3 per cent, which was less than expected thanks to a boost from election mailings resulting from Theresa May’s rash decision to call a snap general election in June.
That may explain why shares inched up 1.7 per cent to 395½p yesterday. Royal Mail expects letter volumes to fall by about 4 to 6 per cent a year in the medium term. However, as banks, government offices and the NHS move further towards digital communications, it is possible that this decline will accelerate.
The continued rise of online shopping provides a steady tailwind to Royal Mail’s parcels operations, where revenues rose 5 per cent. However, it is not as agile as some of its rivals in this sector, such as Amazon and DHL. With relatively high fixed costs, this part of its business may not be best placed to weather a pullback in volumes if economic uncertainty dampens consumer demand, according to analysts at ETX Capital.
The one bright spot is to be found in the company’s General Logistics Systems business. This is its pan-European ground-based parcel delivery service, where revenues were up 9 per cent on volumes that also rose 9 per cent.
Advice Sell
Why A costly labour deal and worsening letter revenue will hit 2018 earnings
British Land
Some of the discounts to net asset value that UK commercial property shares are trading on would seem to imply a catastrophic fall in property prices of which there is as yet no evidence whatsoever.
Even after yesterday’s rise in the shares of 22p to 618½p, British Land is still on a discount of about 30 per cent. This is despite every sign that both its commercial and retail sides, about half each of the total portfolio, are doing as well as anyone could expect.
A 2.6 per cent rise in net assets per share may not be that startling but it is a lot better than a fall.
The collapse in share prices after the referendum last year — British Land fell to below 550p, or a discount of about half to net assets — was understandable in all the turmoil. It now looks overdone.
British Land has two advantages. Its “campus model”, with properties based on three distinct areas, Broadgate, Regent’s Place and Paddington, means it can help ensure the locations are attractive to tenants and their workforce. The huge Canada Water development, 1.8 million sq ft in the first phase alone, will mean the addition of a fourth.
Meanwhile its retail space is at primary locations such as Sheffield’s Meadowhall shopping centre which, footfall figures from the industry suggest, are holding up better than more secondary locations.
To that might be added the cautious stance under which only 4 per cent of its £13.5 billion portfolio is in the form of speculative developments.
Like Land Securities, British Land has chosen to return the proceeds from a big-trophy sale, in its case the so-called Cheesegrater on Leadenhall Street, to a Hong Kong investor, rather than spend this on further exposure to the property market. The £300 million share buyback has admittedly done the share price few favours but indicates the company’s own view that that discount to net assets is too great.
The market may take a while to come around to that point of view or it may not do so at all. The property market could indeed collapse post-Brexit. If you do not believe this will happen, a yield on the shares approaching 5 per cent gives enough reason to hold them along with others in the sector on high discounts.
Advice Buy
Why The shares look cheap and the yield is attractive
