Royal Mail PLC (LON:RMG) shares have risen more than 26% over the past year as the group restructures the business to address falling letter volumes.
But an absence of outstanding news from the postal operator means many analysts have recommended investors either sell while the shares are up or sit tight and wait to see what happens with the restructuring.
The company’s story has remained the same for some time – parcel volumes are rising enough to offset declines in letter volumes.
Tough competition
However, the concern for most analysts is that the parcel business might not be able to keep up the pace of growth amid rising competition from the likes of Amazon.com Inc (NASDAQ:AMZN) and Deutsche Post.
Royal Mail's margins could also take a hit if it decides to cut prices to fend off competition.
“The future of Royal Mail is all about dealing with fierce competition on the parcel deliveries side and achieving productivity improvements across the business, such as through increased automation,” said Russ Mould, investment director at AJ Bell.
"The latter could help to make the sorting and sequencing parcels more efficient and thus free up workers to spend more time delivering items."
‘Financial strings attached’ with restructuring
In response, Royal Mail is restructuring the business to shift its focus on the parcels business.
In its full-year results in May, the group said it expects restructuring costs to be at the upper end of the forecast range of £130-150mln.
READ: Royal Mail's profits drop on pension charge, revenues rise on growth in parcels
“Royal Mail is attempting to transition its business at pace to becoming a leaner operation, with a rather more slick delivery process, although this transformation is inevitably coming with financial strings attached,” said Richard Hunter, head of markets at Interactive Investors.
Labour costs
Analysts at Liberum are also concerned about costs, particularly after Royal Mail agreed a deal with the Communication Workers Union (CMU) to end a long-running dispute over plans to replace the company’s defined benefit pension scheme.
Royal Mail believes the deal on pay, pensions and a shorter working week will improve productivity.
However, Liberum said it remains “concerned about cost headwinds that we do not believe can be mitigated fully by productivity improvements”. The broker maintained a ‘sell’ rating on the stock and target price of 415p.
Potential impact of GDPR
Another issue facing the company is the General Data Protection Regulation (GDPR) that came into effect in May.
The rules, aimed at protecting the personal information of individuals in the European Union, are expected to lead to less marketing mail volumes.
In its first-quarter trading update on Tuesday, Royal Mail said letter volumes for the year could fall outside its guidance range for declines of 4-6% due to the potential impact of GDPR and business uncertainty.
READ: Royal Mail shares jump despite warning GDPR could hit letter volumes more than expected
Business uncertainty
Royal Mail did not elaborate on what it meant by business uncertainty but it’s probably fair to say the company is considering the possible implications of Brexit.
The outcome of the UK’s exit from the EU remains unclear but a ‘hard Brexit’ is widely expected by economist to hurt companies like Royal Mail that have businesses in both regions.
“Brexit and macro-economic uncertainty will weigh on parts of the business,” said Helal Miah investment research analyst at The Share Centre.
“We take a balanced view on the shares and continue with our ‘hold’ recommendation but the shares will still be attractive for income seekers.”
Resilient performance
Despite the challenges, most of which have already been priced in by analysts, Royal Mail has continued to lift revenues, thanks to the strength of its parcels business.
It reported a 2% increase in first-quarter revenue, driven by growth in the international parcels business, General Logistics Systems (GLS).
GLS ‘going from strength to strength’
The company expects a “good performance” in the GLS business although margins may be affected by ongoing labour markets.
To meet a strong demand Royal Mail has expanded GLS in Europe, having opened three new depots in Poland in the first quarter.
“The bright spot in Royal Mail’s numbers remains the GLS international business, which looks to be going from strength of strength, particularly in Europe,” said Nicholas Hyett, equity analyst at Hargreaves Lansdown.
Cost savings
Royal Mail has recognised where its strengths lie by focusing on building up the parcels business while streamlining the rest of its operations to save costs.
The group is targeting £230mln in cost savings in the UK business.
New CEO to lead overhaul
Royal Mail has appointed a new chief executive to lead its restructuring. Rico Back took the helm in June, replacing Moya Green who will retire in September.
Back was the head of GLS for 18 years before taking on the new role.
AJ Bell’s Russ Mould said: “New chief executive Rico Back may be under pressure from shareholders to find ways to accelerate the pace of change in the business. Fortunately, he’s worked for the business for more than 18 years and so can hit the ground running.”
Shareholders may need to exercise patience, however, as the overhaul could take some time to yield benefits.
Attractive dividend yield
In the meantime, investors are being rewarded with a healthy dividend yield of about 5%.
Last year, the company raised its full year dividend by 4% to 24p each as it swung to net cash of £14mln from net debt of £338mln.
Former boss Green has indicated the group will continue to reward its shareholders.
"The good cash generation characteristics of our business will support our progressive dividend policy,” she said in her last full year results statement in May.