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Royal Mail needs to hike dividend above market forecasts to support shares, says RBC

RBC downgraded the stock to ‘underperform’ from ‘sector perform’ but raised its target price to 500p from 465p.

Royal Mail
Royal Mail faces the challenge of keeping both shareholders and employees happy

Royal Mail PLC (LON:RMG) will need to raise its full year dividend well above market forecasts to support the current share price, RBC Capital Markets said.

RBC downgraded the stock to ‘underperform’ from ‘sector perform’ but raised its target price to 500p from 465p.

The broker said the postal operator’s shares trade at a premium to income peers, requiring a 20-25% beat on the full year dividend per share (DPS) consensus forecast to justify the price.  

“While possible, stakeholder issues suggest it is not as probable as the shares have priced in, so we move to underperform, target price 500p,” it said.

“This is the level at which investors should re-engage with the shares for long-term restructuring potential.”

It expects Royal Mail to raise its DPS to 0.24p in fiscal 2017/18 from 0.23p last year, representing a dividend yield of 4.2%.

Balancing pension and wage demands against dividends

One of the challenges facing Royal Mail is trying to keep shareholders happy with dividends while meeting demands from employees and the unions representing them, RBC said. 

Royal Mail reached an agreement with the Communications Workers Union in February over pensions, pay, a shorter working week, culture and operational changes.

“In less than 24 months the parties need to renegotiate,” RBC pointed out.

“Lifting DPS aggressively would likely create tension and challenges of higher wage demands for 2020 – risking long-term value/growth & a later DPS cut for short-term effects.”

Parcel revenues need to grow 9-10% per year, says RBC

Another challenge for Royal Mail is growing parcel revenues enough to offset declining letter volumes.  

RBC said parcel revenues need to rise by 9-10% per year to lift profits to increase the dividend to what is priced in. Between 2014 and 2017 revenue growth averaged 2% per year and is expected to increase 4.1% in fiscal year 2018.

“As UK business to consumer e-commerce matures, we forecast that for RMG to deliver 9%-10% revenues growth in parcels will be challenging as it would require about 13% per annum volume growth,” the broker said.

Royal Mail parcel business has faced tougher competition from the likes of Amazon.com Inc (NASDAQ:AMZN) and Deutsche Post. However, in a February trading update it said its “continuing good trading performance means that we now expect to deliver adjusted group operating profit before transformation costs for 2017-18 of at least £680mln”.

READ: Royal Mail highlights “continuing good trading” performance, as it confirms agreement in principle with union

Quick facts: Royal Mail PLC

Price: 170.202 GBX

LSE:RMG
Market: LSE
Market Cap: £1.7 billion
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