BIG NEWS

We re­luc­tantly turn bear­ish on the trans­port group as a ma­jor set­back changes the in­vest­ment case

Shares - - CONTENTS -

Time to sell Royal Mail shares / Air­line sec­tor still in the dan­ger zone / House­builders hit by for­eign buy­ers’ tax plan / Shur­gard’s €2.4bn IPO / Ocado, Just Eat, Right­move and oth­ers se­lected for new re­li­able growth list / As­ton Martin and Fund­ing Cir­cle’s shaky starts

In­vestors who have been drawn to Royal Mail’s

(RMG) shares as a source of gen­er­ous in­come may soon be in for a shock un­less the busi­ness sees a rad­i­cal im­prove­ment with its ef­fi­ciency plan.

A ma­jor profit warn­ing on 1 Oc­to­ber has seen the share price fall by 23% to 368p over two days. An­a­lysts have had to sig­nif­i­cantly down­grade earn­ings fore­casts be­cause of lower than ex­pected pro­duc­tiv­ity gains and cost sav­ings.

The re­duc­tion in profit is ex­pected to re­sult in lower free cash flow, thus ques­tions are now be­ing asked over whether it can af­ford to pay div­i­dends at cur­rent lev­els.

Prior to the profit warn­ing the shares yielded a prospec­tive 5.2% yield based on a 477.1p share price and con­sen­sus fore­cast 24.87p div­i­dend pay­ment for the year to March 2019.

The prospec­tive yield now stands at 6.8% based on the same div­i­dend fore­cast. That looks too high given its sit­u­a­tion. Liberum an­a­lyst Gerald Khoo says man­age­ment com­mit­ted to div­i­dend growth on a con­fer­ence call fol­low­ing the profit warn­ing. Khoo has re­duced his div­i­dend fore­cast to 24.4p to show to­ken growth of 1.5% per year.

‘Even at this level, we see the pay­out be­ing barely cov­ered by earn­ings and cash flow this year, ad­mit­tedly with ad­verse tim­ing dis­tor­tions on cash flow this year, and un­der­ly­ing cover de­te­ri­o­rat­ing in later years.

‘Man­age­ment has stated that it would not pay div­i­dends out of in­creases in debt, so we see the div­i­dend as highly vul­ner­a­ble to any fur­ther de­te­ri­o­ra­tion in trad­ing.’

Royal Mail say its UK pro­duc­tiv­ity per­for­mance is ‘sig­nif­i­cantly’ be­low plan at 0.1% in the six months to 23 Septem­ber, down from a tar­get of ap­prox­i­mately 3%.

Un­for­tu­nately, this has had a knock-on im­pact on cut­ting costs with the tar­get cut from £230m to £100m in 2018-2019.

Pro­duc­tiv­ity im­prove­ments are vi­tal for Royal Mail's fu­ture as it needs to drive earn­ings and fight back against fierce com­pe­ti­tion.

In a triple whammy of bad news, ad­dressed let­ter vol­umes have dropped 7% amid de­clin­ing mar­ket­ing mail as struc­tural de­cline, busi­ness un­cer­tainty and GDPR data pro­tec­tion rules made an im­pact.

Royal Mail has a unique mar­ket po­si­tion in the UK and its over­seas busi­ness is grow­ing fast. Un­for­tu­nately its near-term fu­ture from an in­vest­ment per­spec­tive is clouded by mar­gins and cash flows com­ing un­der sig­nif­i­cant pres­sure.

For those lat­ter rea­sons, we re­luc­tantly switch to a ‘sell’ rat­ing on the stock in an­tic­i­pa­tion that the shares have lit­tle chance of re­cov­er­ing un­til man­age­ment can pro­vide ev­i­dence of higher pro­duc­tiv­ity gains. (DC/LMJ)

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