UK Edition
We often talk about disruption in this column and few businesses have found themselves on the receiving end of it more than Royal Mail.
Not long ago, the letters, bills and statements that came through our letter boxes every morning were essential to the running of our everyday lives. Now all those communications can be electronic. These days we are far more likely to depend on Royal Mail as the conduit for our online shopping and returns.
A line in the company’s interim report published in November spelt it out: “For the first time, parcels revenue at Royal Mail is now larger than letters revenue.” Its future depends on managing the shift in its centre of gravity from letters to parcels successfully.
When this column last covered Royal Mail, in November 2019, we were pessimistic. Quoting its admission that “our UK network is primarily configured to quickly and efficiently deliver letters [and] we want to invest £1.8bn to ensure we can more efficiently and effectively process and deliver the changing traffic mix”, we said Royal Mail gave us the feeling it had only just realised what had happened in its markets and that the process of transformation was about to begin.
“But,” we pointed out, “the decline of letters and the growth of parcels have been obvious to everyone for years. Royal Mail gives the impression of being hopelessly off the pace.”
Then there were the company’s perennial problems with its workers: it admitted that the industrial relations environment was “slowing our rate of change”, which was “likely to impact our rate of productivity improvement”.
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This bleak landscape prompted us to advise readers to sell the shares.
To say a lot has changed since then is an understatement. The pandemic has given an enormous boost to online shopping, Royal Mail has a new chief executive and the company has reached an agreement over working practices with the Communication Workers Union (CWU).
The shares have responded by tripling in nine months. We can kick ourselves for our mistimed advice but we must also look coolly at the challenges that face the business now.
The first is that its vital transformation into an efficient parcel deliverer is still in its infancy. Although the agreement with the CWU will ease the introduction of more responsive working practices, automation of parcel sorting is essential if it is to make the margins needed for a sustainable future.
Giant automated hubs able to sort millions of parcels a day are being built but in November’s interims the company said parcel automation remained at about 33pc. Only time will tell if the introduction of automation can be implemented successfully and deliver the cost savings needed.
Automation normally goes hand in hand with job cuts so it remains to be seen if the agreement with the union will prove strong enough to allow the process to be completed, although one former investor in the company said postal workers might have watched Amazon build an efficient delivery business from scratch in a few years and wondered if their employer had a future if it failed to modernise.
That is the second challenge: competition. Royal Mail has enjoyed an effective monopoly in letters but there is plenty of choice when it comes to sending parcels.
“By rights the likes of Hermes and DPD should not exist,” the former investor said. “Royal Mail has such huge strengths in its network, in having its postmen pass every house in the country every day. Those rivals do exist because Royal Mail has not been well run and has not made full use of its strengths. If it can start to give people the service they want – via initiatives such as collecting returns from their homes, for example – it has a future.”
The final uncertainty is over whether enthusiasm for online shopping will survive the end of the pandemic. Here, at least, the signs from countries ahead of us in the emergence from lockdown, such as China, are encouraging.
Royal Mail’s shares look cheap at a multiple of predicted earnings of about 10. The danger lies in how much those earnings can be sustained as its transformation speeds up and the pandemic winds down.
Shareholders were burnt before by the failure of Royal Mail’s bosses to get a grip on its plight. It appears to be finally facing up to the scale of the challenge but it’s still very early days. We’ll steer clear for now.
Questor says: avoid
Ticker: RMG
Share price at close: 519p
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