November 27, 2014    5 minute read

Royal Mail or Royal Fail?

   November 27, 2014    5 minute read

Royal Mail or Royal Fail?

Operating since 1516, after Henry VIII established a ‘Master of the Posts’; having undergone corporatisation, modernisation and most recently privatisation; and considering the integral role it has and continues to play in our daily lives, Royal Mail PLC is a business adorned in history. And yet, with share prices falling, and pre-tax profits experiencing a similar fate, is its future becoming increasingly uncertain?

Background

Following the 2010 General Election, Vince Cable, the Business Secretary of the Coalition Government, announced the 2011 Postal Services Act. This piece of legislation allowed 90% of the Royal Mail to be privatised, leaving the remaining 10% to its employees; this was highly controversial. The Scottish National Party even pledged to renationalise Royal Mail in Scotland if successful in claiming independence and the Communications Workers Union (CMU) took industrial action following its privatisation.

While 30% of the Royal Mail would remain owned by the Government, the majority would now be available to the public through the London Stock Exchange. Conditional trading began on 11 October 2013, ahead of the full listing on 15 October 2013, with shares being floated at 330p, despite numerous higher valuations from a variety of banks and financial institutions.

With stocks growing as much as 65% in the first eight days of trading and eventually reaching a high of 618p, 87% higher than the initial price, numerous MPs and two investment banks claimed the public and the government respectively, had lost £1bn in the sale of Royal Mail. While Vince Cable defended the decision, telling the BBC, ‘they now have the benefit of hindsight, which we didn‘t have at the time. We sold at a price that was regarded as the best that could be achieved in the context in which we sold it’, intense scrutinisation continued.

With shares closing at 430.60p this Friday, allowing its continued existence on the FTSE 100 Index, it is clear that there may have been a slight miscalculation. Nevertheless, with increased competition, a drop in pre-tax profits, and speculation from investors, Royal Mail’s market share and future is under threat.

Competition

In the run up to Christmas, traditionally Royal Mail’s busiest month, there is no doubt that the company is feeling the pressure from direct rivals. Amazon continues to ‘eat away’ at Royal Mail’s parcel delivery service, and the emergence of Whistl, formerly TNT Post, adding to the problems. Royal Mail have even claimed that the rise of Whistl could mean a loss of £200m in sales. With its parcel delivery division seeing revenue fall by 1% and the volume of its letter business dropping by 3%, Royal Mail’s core business activities are undeniably being tested.

Furthermore, Royal Mail’s ability to respond to these challenges is also constrained. Their duty to operate under the Universal Service Obligation, which ensures delivery to all 29 million addresses in the United Kingdom, 6 days a week, for a single given price, means the changes they can implement are limited. Royal Mail even describes how there is now a ‘material risk’ to their continued operations. Certainly there is an argument that EU Competition Law allows private enterprises to ‘cherry-pick’ the most affluent areas to profit from. At a scheduled meeting next week, the CMU will challenge the Business Select Committee on the case for tougher regulations in order to address the clear imbalance in the market against Royal Mail.

Ofcom however, the postal services regulator, isn’t convinced. In a statement it said, ‘Protecting the universal service is at the heart of Ofcom’s work, and our own evidence clearly shows that the service is not currently under threat’. With little sign of support from either Ofcom or the Business Select Committee it is difficult to see from where Royal Mail will be able to regain the initiative.

Nevertheless, the firm‘s international parcel delivery service, GLS, that operates directly in 22 European countries, and another 15 countries and nation-states through partner groups, is experiencing a different fate. Revenue is up by 7%, enabling the company’s overall revenue to rise by just £5m to over £4.52bn. On the other hand, overall it is apparent how the move to privatisation and the rise of competition is having a monumental impact Royal Mail’s operations, and ultimately it is difficult to see how they will be able to respond.

Long Term

For investors there is clear concern. Falling profits and increased competition have resulted in a dramatic increase in market speculation. The result has been a sharp decline in the share price in recent days. However, in the long term, shares are still up by 31% from the initial 330p, and as a business it is still highly profitable, making £279m in operating profit in the first sixth months of this year. Furthermore, as John Ficenec, Questor Editor describes, the long-term concern for investors should be Royal Mail’s cash generation and dividend payments, and the dominant position in the postal market that it retains. Overall the advice for current investors would be to hold.

Indeed, contrary to current Questor advice, an analysis of the 16 investors‘ shareholdings compiled by the Telegraph using Bloomberg data shows that eight of the initial investors have reduced their stakes in Royal Mail by more than 90%. According to the Bloomberg data, six investors – Capital Research, Standard Life, Och Ziff, Soros, Lazard and Third Point – have sold their entire stakes. JP Morgan Asset Management and Schroders have sold 94.5% and 91.8%. Only three have increased their holdings. For these investors, the potential profit margin has the potential to be high.

The future, while ostensibly a worry, has some cause for optimism. Although Royal Mail remains behind the times in terms of technology, steps are being taken. It is currently trialling a Sunday delivery service and has slashed prices on smaller packages ahead of this Christmas. With more investment it is clear Royal Mail can continue to be successful and increase profit margins.

Nonetheless, success through investment is not guaranteed. Royal Mail does need more protection from Ofcom to ensure the market remains competitive. Without this, the likes of Amazon and Whistl will begin to dominate the postal services, meaning the ‘Master of the Posts’ will enter into obscurity.

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