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Royal Mail's war with workers risks refinancing and dividend cut

“The huge task ahead to reinvent Royal Mail is likely to be a very drawn-out transformation with no guarantees that there will be a leaner, meaner business at the end of it,” one analyst said

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No empty threat: Royal Mail is gearing up to build an automated 'parcel hub' in Warrington

Analysts have warned that Royal Mail Group PLC (LON:RMG) is at risk of a refinancing and dividend cut as the letters and parcels group struggles against low productivity and industrial action.

But with chief executive Rico Back essentially saying that enough is enough and going ahead with the roll-out of fully automated parcel-sorting depots, even without resolving problems with trade unions, can the company stop the decline that has seen its shares sink to a new all-time low? 

READ: Royal Mail begins robot roll-out as more strikes loom

The FTSE 250 group warned in a third-quarter update on Thursday that it expected letter volumes for the coming year will decline more than it previously thought, increasing the likelihood that its UK business will be loss-making.

With net debt above £310mln at the half-year stage, the “dismal outlook” for UK parcels and letters “means the possibility of the group requiring refinancing becomes increasingly likely”, analysts at Peel Hunt said.

At the heart of Royal Mail’s troubles are the productivity of its sprawling former state-owned UK business, which is battling structural changes in its market as people send fewer letters but receive more parcels from the rise in online shopping.

While Back and his believers can spy the sunlit uplands of a future where the company can enjoy the fruits of this parcel shift, the company has sizeable problems to negotiate with its large workforce.

Fraught relations

Agreement of a deal on pay, pensions and working hours in March 2018 sent the shares to a high above 600p, but the management’s relationship with its workers has deteriorated with leadership changes and ambitious productivity targets not being met.

The Communication Workers Union’s (CWU) plan to go on strike in December was blocked in the courts by the company.

CEO Back, who was promoted from head of the parcels business several months after his predecessor agreed the pay deal, said the perceived risk of strikes had led to some parcels customers switching some volumes to Royal Mail’s competitors.

What’s more, the CWU is now balloting for another strike.

This comes as productivity at Royal Mail improved only 1.3% in the nine months of its current financial year to March, and is expected to be only 1.5% for the year compared to a target of over 2%. 

With analysts saying that unless there is major progress in wrestling the transformation plan back on track, the company will fall well short of its 2024 targets, Back said the company wants to reach an agreement with the CWU but was going ahead with automation as “we cannot afford to delay this essential transformation any longer”.

But CWU deputy general secretary Terry Pullinger threw the blame back at Back. 

“These results are the consequence of gross mismanagement of this great public service. Ever since the new board appointed their choice of a new CEO and his team in 2018, this organisation has been on a downward spiral.

“They inherited an organisation when industrial relations were harmonious, a new blueprint agreement was in place and was being deployed at pace on how we jointly approach the challenges of the future.”

He said it was down to the “mismanagement” of the industry, adding: “The business has a one trick pony vision of just growing parcels.

“They have stated to the union that our contribution to society in the UK is no longer about service but all about profit. It is evident that in their eyes, Royal Mail is no longer a great public service that can generate revenue by merging entrepreneurism, innovation and social aims but a privatised public service in the grip of a potential corporate raid of greed.”

Downsides and dividends

Broker Liberum sees a strong risk for more downside, suggesting last year’s letters price hike was accelerating the structural decline in volumes on top of the poor progress on productivity.

AJ Bell’s investment director Russ Mould said Royal Mail “has to reshape its business for the future while also operating against a difficult backdrop”, which has also seen rivals UPS and FedEx also warn of the tough market, but the threat of strikes could make Royal Mail’s customers think twice about wanting to use its delivery services.

“The huge task ahead to reinvent Royal Mail is likely to be a very drawn-out transformation with no guarantees that there will be a leaner, meaner business at the end of it,” said Mould.

Peel Hunt's and Liberum’s are among the analysts with ‘sell’ recommendations for their clients, though the latter said the dividend yield of 7.9% “is notionally supportive”. 

Berenberg said this week warned about the viability of the dividend if the turnaround cannot be achieved on time.

“Thanks to the cuts to earnings and elevated capex, we expect the company to generate very little cash flow in FY21E and FY22E and, on our numbers, FCF will be unable to cover the dividend for those years. 

“An uptick in earnings should come to the rescue by FY24E but, if there are further delays to the turnaround plan, then we think the risk that the dividend is cut again will re-emerge.”

Quick facts: Royal Mail PLC

Price: 159.2 GBX

LSE:RMG
Market: LSE
Market Cap: £1.59 billion
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