Royal Mail bounces despite pension problems

After Royal Mail shares hit a two-and-a-half-year low Monday, investors could be forgiven for approaching today's first-quarter trading update with some trepidation. They needn't have, but are shares in the letters and parcels giant really a bargain?

Yesterday was the first time since December 2014 that the iconic postal service had closed a session below £4. In fact, it was only the 22nd time that has happened since listing with much fanfare in October 2013.

All told, it had seen a fall of almost 12% since full-year results beat expectations two months ago. Pension travails have weighed on the stock ever since and it now faces a nationwide strike should negotiations fail.

But investors made sure that magic 400p remained a major support line, bidding shares up as much as 4% Tuesday to 415p after chief executive Moya Greene said the company had made "a good start to the financial year".

On an underlying basis, group revenue was up 1%. The better performers were parcel volumes and revenues, which saw 5% and 3% upticks respectively, and the European parcels business General Logistics Systems (GLS), which continues to impress.

GLS volumes and revenues were up 5% and 6% respectively, with Italy doing especially well. Including the impact of recent acquisitions - including Spanish express parcels delivery firm ASM, which is performing well - GLS revenue was up around 18% on a constant currency basis.

Elsewhere, UK Parcels, International & Letters (UKPIL) weakened once again, with underlying revenue down 1%. Addressed letter volumes fell 6%, though letter revenue was down a more modest and top-of-the-range 4%, benefiting from general election 2017 leafletting.

"We remain on track to deliver our cost avoidance and net cash investment targets for the full year," Greene added.

Pension problems

The pension dispute still hangs over Royal Mail, though. It is currently in the process of closing its current defined benefit (DB) scheme, which it claims will cost it £1 billion in contributions annually.

RMG's latest offer last week would give employees a choice between a DB cash balance scheme and a defined contribution scheme. This proposal would cost no more than £400 million a year, we're told.

However, its main trade union rejected the offer, raising the prospect of a strike. Fellow union Unite reckons it's the "best achievable [offer] in the circumstances", which doesn't fill us with confidence that a strike will be avoided.

Royal Mail stock offers investors an attractive yield, with the forecast yield on 2018 numbers at 5.8% and covered 1.6 times by consensus earnings of 39.1p.

Cantor Fitzgerald analyst Robin Byde notes its forward price/earnings (PE) ratio of 10.5 times offers a 20% discount to the sector. Byde is more positive on the stock than his peers, with a target price of 450p, although he still only rates RMG has a 'hold'.

Other analysts are more hostile.

Despite a mixed update, Gerald Khoo at Liberum still rates the shares a 'sell' with 385p price target.

Dominic Edridge at UBS is a seller too, with target at 390p. "We believe that UK parcel risks are to the downside, whilst the outlook for UK letters remains weak," he said Tuesday. "We see limited reaction to these results given the additional overhang of the pension situation."

Indeed, down 11% year-to-date, there seems little chance of a rebound until we finally get a resolution to the pensions problem. However, current trading, that dividend yield, modest valuation and technical support at 390-400p should limit downside.

And the future would be considerably brighter if RMG managed to avoid strike action and keep cost-cutting on track.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.