Is Royal Mail still on track for FTSE 100 promotion?

A swift return to the FTSE 100 Index for Royal Mail remained on the cards today after a decent Christmas performance offered more evidence that the logistics giant is on the right track.

Although shares fell back 2% in the wake of today's update, the stock is still up by more than 22% since mid-November. It lost its place in the FTSE 100 Index in September, having seen shares driven lower by the possibility of industrial action on pay and pensions.

Those fears have receded somewhat in recent weeks after the start of mediation talks with the Communications Workers Union removed the threat of a hugely damaging strike in the run-up to Christmas.

This enabled Royal Mail to deliver a festive performance in which its UK parcel revenues and volumes continued to show steady growth, while there was a resilient performance for its declining letters business.

But the stand-out performance came from its European parcel delivery operation, GLS, which grew revenues and volumes by 10% in the first nine months of the financial year.

Chief executive Moya Greene said it had been a good performance over the Christmas period, with Royal Mail still the leading player in UK e-commerce after delivering 149 million parcels in December alone. Parcel revenues rose by 4% in the first three quarters of the year, offsetting a 3% decline for letters.

Greene remains confident that Royal Mail will be able reach agreement on an affordable and sustainable pension solution and a pay deal that will "enable us to continue to innovate and grow".

The parties are discussing proposals from mediator Professor Lynette Harris, who has recommended the introduction of a collective defined contribution pension scheme with a defined benefit element for all workers.

On wages and the working week, she has proposed a 2.6% pay rise from April 2017 followed by a 2% rise from next April. A one-hour reduction to the working week  - currently 39 hours - is conditional on delivery methods trials, automated hours data capture and later delivery times.

The progress on talks has helped the shares climb as high as 462p in recent days, although Investec Securities has said it thinks the stock can hit 500p. It has pointed out that Royal Mail is trading on an earnings multiple that is a significant discount to its European peers.

Interactive investor's Head of Markets, Richard Hunter, said the dividend yield of around 5%, current and projected, was a particular attraction for investors. However, he added that challenges inevitably remain for the business, with fierce competition likely from Deutsche Post in parcel deliveries.

He added: "Elsewhere, the long-awaited fallout from Brexit negotiations could impact spending and investment decisions on a wider basis in the economy and, until the staff negotiations are concluded, an element of uncertainty will remain."

UBS analyst Dominic Edridge is slightly more cautious about Royal Mail, having maintained his 400p price target. He said the decline in UK letters was slightly better than expected, although he flagged the potential for labour cost inflation to offset the revenue acceleration in the GLS performance.

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