Are Royal Mail shares too cheap to miss?

| Last Updated June 27, 2022

potential of investing in Royal Mail shares

Key Points

  • Royal Mail’s share price is down over 53% in the past year after delivering tremendous growth in 2021 to investors.
  • The company has over 52% by volume of the domestic parcel market in the UK.
  • Management is heavily investing into parcel automation.

Royal Mail (LSE:RMG) shares are down over 47% year to date. In contrast, the FTSE 100 has remained relatively flat over the same period. But what’s behind this impressive decline? And is it actually a buying opportunity for my portfolio? Let’s take a closer look at this British stock.

What do the fundamentals say about Royal Mail shares?

Royal Mail Group is a multinational postal service provider. While it operates in continental Europe under its GLS brand, primary operations are located inside the UK, with 52% of parcel volumes delivered there.

In 2021, Royal Mail’s revenue performance was majorly driven by GLS. However, it was insufficient to maintain operating profits that had received a nice boost from the pandemic. After all, with everyone stuck at home, e-commerce stocks went through the roof.

This tailwind has since waned, and parcel delivery volumes have started to fall. This seems to be one of the main concerns amongst investors today. However, I feel it’s worth noting that despite the recent decline, parcel volumes are still firmly ahead of pre-pandemic levels by just over 30%.

In an attempt to better streamline the business, management has been heavily investing in automation solutions at its various fulfilment facilities. And this transformation programme has already delivered around £59m in value during 2021. With the cost of labour on the rise, seeing automation become a more centric part of this business is encouraging in my mind.

Risks lying ahead

Royal Mail currently retains the largest market share in the United Kingdom for parcel delivery networks. That undoubtedly gives it a size advantage, yet the business remains far from risk-free. The company has long since had disputes with its workers’ unions. And while a resolution was briefly found, the relationship between management and Royal Mail workers is once again strained as inflation accelerates.

Its competitors don’t seem to be restricted in such a manner. And with more nimble operations, many appear to be outmanoeuvring this business as it focuses on its slow transformation plan.

With margins already tight, rising wages could put a hamper on organic growth. And with debt becoming more expensive thanks to rising interest rates, external funding may also be in short supply. Of course, the company could choose to not increase employee salaries in line with inflation. But as this group’s past performance has shown time and time again, a worker strike would likely be inevitable if this path is taken.

With that in mind, I think it’s fair to say that Royal Mails are caught between a rock and a hard place at the moment.

What’s next for Royal Mail shares

After surging by more than 50% last year, the share price has since fallen and lost all of these gains. In fact, the company’s stock is down over 53% in the last 52 weeks. Does this give me a good bargain at its current price?

Maybe. It’s worth remembering that the stock market has been hit hard this year thanks to investor fears surrounding inflation. Aside from the risk-averse investing climate we’re currently in, the fundamentals of Royal Mail don’t look too bad, in my opinion. Or at least they don’t merit such a low price-to-earnings ratio of less than five. That’s why I think this could be a buying opportunity for my portfolio.

Having said that, there remains the risk that this is a value trap. There seems to be a lot of uncertainty about the future of this business and its competitive environment. That’s why personally, I’m going to keep this “cheap” stock on my watchlist for now.

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Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.