Royal Mail Group PLC (LON:RMG) is likely to announce a "significant dividend cut" as it faces major strategic and structural challenges, Liberum said.
The postal operator on Tuesday cut the upper range of its 2019 profit guidance as it continued to struggle with falling letter volumes. It also warned that next year, it expects letter volumes to decline more than previously estimated and parcel deliveries to slow.
Liberum repeated a ‘sell’ recommendation for the shares and cut its target price to 240p from 269p, saying revenue continues to be stagnant as accelerating declines in letters offset growth in parcels.
In the first nine months of 2019, total revenue rose 2%, which comprised of a 6% drop in letters, a 6% increase in UK parcels and an 8% increase in the international arm Global Logistics Systems (GLS).
GLS continued to face cost pressures in Europe and the US, amid tough competition but cost savings and pricing initiatives mean the firm continues to target an adjusted operating profit margin of more than 6% for the year.
Productivity remains 'biggest challenge' for Royal Mail
Liberum also pointed out that productivity delivery failures have seen costs rise to squeeze margins.
Royal Mail had hoped that a deal with the Communication Workers Union on pay and pensions would have boosted productivity but it is yet to see any improvements. In the first half, productivity fell 0.2%, well below target, leading the company to say it now expects its performance for the year to be ”significantly below” its original estimate, which was towards the upper end of 2% to 3%.
In Tuesday’s trading update, Royal Mail said its assessment of the productivity and efficiency opportunities under its agreement with the CWU and through its UK network review were ongoing. “The findings from these reviews will help to inform the financial framework of our strategic plan,” it said.
Liberum believes productivity remains its biggest challenge.
“The productivity improvements that kept the cost base stable to defend UK margins in the past have stalled,” it said.
“Even if the previous run rate of 2-3% annual improvements can be restored, which is by no means certain, we see this as a speed limit to productivity gains that cannot be exceeded with incremental measures. In turn, this means the margin shortfall cannot be reversed.”
Liberum thinks Royal Mail should use cash to fund restructuring instead of dividend
The broker thinks the dividend is unsustainable, given that the current commitment represents a yield of 9%.
While the dividend would appear to be covered by in-year trading cash flow, the cover is more marginal in following years, Liberum said.
Liberum believes rather than paying a dividend, Royal Mail could use the cash it has to fund a restructuring programme and additional investment to drive productivity improvements.
This would be preferable to raising leverage or issuing new equity, it said.
Dividend suspension 'cannot be ruled out'
“We think it is unlikely that the dividend will be suspended altogether, although that cannot be ruled out,” Liberum said.
“We suspect the postponement of the capital markets day until after the FY results in May (previously tentatively scheduled for March) gives time for the board to consider the dividend in the context of whatever new strategy management bring forward."
Liberum assumes the final dividend for the current year will be passed, giving a full year dividend of 8p per share from the interim payout.
It expects the future annual payment will be rebased to this level, saving the company £333mln in cash over the next two years.
"We forecast a significant dividend cut.
In late-morning trading, shares were little changed at 269.4p on the day but have fallen more than 11% since the start of the week.