Gamble of the week: Royal Mail’s plucky rival

The privatisation of Royal Mail continues to take up a lot of column inches. But meanwhile, this smaller rival – the country’s largest independent postal operator – is quietly getting on with making money.

The business has been around since 1971 and up until 2009 was known as Business Post. It just announced a 28% jump in full-year pre-tax profits. Despite a strong run up in the share price over the last 18 months, I think it could be a good long-term bet.

You won’t see any of its posties pounding the streets. It works in partnership with Royal Mail, who deliver its letters for it. UK Mail (LSE: UKM) gets a lot of its letter business from financial, publishing, retail and utility firms, and makes a decent profit from them.

But the real reason to invest in UK Mail is not letters, but parcels, where volumes grew by 19% last year. More of us are doing our shopping online, which is leading to rapid growth in parcel deliveries.

This is a very crowded market, with the likes of Royal Mail, DPD and Yodel throwing a lot of money at it. So, to be a good investment, a business has to have a competitive edge – and I think UK Mail has it, in the form of its delivery network.

It all stems from a central hub in the Midlands, spreading out to 50 sites across the UK. By combining its letters and parcels business across the same network, UK Mail is able to get lower unit costs than many of its rivals, better efficiency and better customer service levels. This makes it very profitable.

A new hub and extra sites are being built, adding more capacity. As more of the sorting becomes automated, this should feed through to more efficiency and lower costs, reinforcing its competitive position. This should allow UK Mail to take a bigger slice of the parcels market.

UK Mail share price chartIt has also been very good at helping its customers. Heavy investment in IT has enabled the firm to give customers one-hour delivery slots and ten minute notifications. This keeps both the sender and receiver of the parcel happy.

The firm is also expanding into niche businesses, such as packets delivery and digital printing, which have the potential to boost profits. Parcels growth will slow this year because it will be tough to replicate last year’s stellar performance.

UK Mail is also a little short of capacity until its new hub is finished in 2015. The shares are no bargain on nearly 18 times forecast earnings, but UK Mail looks capable of growing strongly over the next few years.

The big risk for investors is that the new hub disrupts its business and leads to poor service and a loss of customers – but assuming it avoids this, it should be able to takes market share from Royal Mail while benefiting from growth in the parcels market.

Verdict: buy