Royal Mail will deliver for investors – here's how to play it

One of the most unlikely winners from the last 18 months has been Royal Mail. At the start of 2020 it was in disarray. Mail volumes were falling and it had a fractious relationship with its staff; the share price languished 50% below 2013’s flotation price. It then halved again amid the brief market crash that followed the imposition of a national lockdown. However, over the past 18 months the shares have been on a tear, at one point nearly rising to five times their March 2020 price. Even today they are still up by around 300%.

Royal Mail has benefited from the huge rise in parcel volumes caused by the shift to online shopping as stores closed. For the first time in its history sales from parcels have eclipsed revenue from letters. In fact, the increase has been so large than it is now starting to deliver parcels from certain retailers on Sundays, something unthinkable a few years ago, when all the talk was about whether to reduce deliveries in order to manage decline and
cut costs.

Royal Mail still faces stiff competition

Of course, there is always the risk that this surge in business could reverse as people cut back on online deliveries in favour of returning to high-street shops. Early data suggest that parcel deliveries have declined a little in recent weeks. Royal Mail also faces competition from several companies when it comes to delivering parcels. One, DPD, recently secured a deal with the Post Office allowing people to pick up its parcels at some outlets (the Post Office and Royal Mail, while separate entities, had had an exclusive relationship until the DPD agreement). All this means that Royal Mail admits that revenues are unlikely to keep growing at the same rate.

Nevertheless, Royal Mail’s sales are expected to keep rising, while it finally seems to have sorted out its problems with the trade unions. I’m particularly impressed by the fact that former Ocado executive Simon Thompson, who has been Royal Mail’s CEO since January, seems eager to invest in technology to cut costs and keep it at the cutting-edge of parcel delivery. For example, it has been investing in drone deliveries, using them to deliver some mail from the British mainland to the Isles of Scilly.

GLS: a solid foreign subsidiary

Note too that Royal Mail isn’t just limited to the UK. It owns a subsidiary known as GLS, which focuses on parcel delivery in Europe, Canada and the US. GLS has also done well during the past two years, its revenue increasing by nearly 30%. Royal Mail also looks appealing from a valuation perspective, delivering a solid dividend yield of 4.3% and trading at eight times 2022 earnings. Its sizeable property portfolio means that it also valued at only slightly more than its book value.

Royal Mail shares are currently 20% off their recent highs and below their 50-day moving average, so wait a little for the shares to start rising again. However, once they pass 550p, go long at £4 per 1p, setting a stop-loss at 301p. This will give you a potential downside of £996.