There has been a lot of controversy over whether Royal Mail (LON:RMG) shares were sold off too cheaply, but UBS now believes the stock is too dear.
Royal Mail shares closed at 550p on Tuesday, two-thirds higher than the flotation price of 330p, and the shares are now “priced for perfection”, says UBS, one of the banking giants that masterminded the initial public offering (IPO) of the formerly state-owned institution.
Coincidently (or not), UBS’s ‘sell’ note comes on the day that advisers from the firm are due to appear before Members of Parliament (MPs) who are looking into whether the British tax-payer was rooked by the City in the privatisation.
UBS is effusive about Royal Mail management’s achievements thus far, and says it expects further improvements, due to productivity and revenue growth.
“However, with Royal Mail’s share price up 69% since the IPO (versus 7-32% for peers), we believe the market is over-estimating margin upside. In particular, we believe it will be difficult to accelerate its transformation, given the limitations of the labour agreement. To get to the upper end of the 5-10% regulated range (assumed by the market; current 3%) would require acceleration of staff reductions, additional automation and no adverse events,” UBS says.
The Swiss bank cites Royal Mail’s “almost entirely fixed cost base”, with staff accounting for 61% of total fixed costs, and notes the limited scope for improvements in efficiency on the letter delivery side of the business through further automation.
UBS says the parcels business is where the market should be looking for efficiency improvements, and parcel automation could deliver significant improvements in efficiency, but changes are likely to take time to implement, due to current staffing levels, and the time scale may disappoint the market.
“We are positive on parcel growth, but note the UK parcel market is highly competitive. We believe it is only for parcels of less than 2kg where RMG has a major cost advantage, very high market share and re-pricing potential. Therefore, RMG’s future growth will be highly dependent on which parcel size grows. We also believe there is a growing disconnect between parcel and internet retail growth, with the rise of “click and collect” and other such hybrid models reducing the need for parcels,” UBS noted.
The Swiss outfit has initiated coverage of Royal Mail with a 450p price target. Shares were down 1.3% at 542.7p in mid-morning trade, valuing the company at £5.4bn, or about £2.1bn more than the price at which the company was valued in the IPO.
UBS is not the first party to recommend selling Royal Mail shares; business secretary Vince Cable issued advice, of sorts, to sell the stock back in mid-October, when he said that the taxpayer had not been short-changed and urged people to look again at the stock when it settles in three or six months' time.
He said the price was set on the basis of advice, and taking into account market conditions and similar flotations of other postal businesses.
Meanwhile, as shares in Royal Mail take the low road, demand for the firm’s £344mln-valued rival UK Mail (LON:UKM) surged on Wednesday as the company issued an upbeat trading statement that seemed to confirm UBS’s view that parcels is where it is at for delivery firms.
UK Mail’s parcels business, which represents 43% of the group's overall revenues, saw revenue growth of 21.4% in the six months to end September compared to last year.
This growth was supported by average daily volume growth of 25%-largely driven by an increase in home deliveries, the company said.
Overall, the group's pre-tax profit increased 63% to £11.9 million, compared to £7.3mln in 2012.
UK Mail shares were up 7.7% at 630p, just 15p off the stock’s 52-week high.