Ahead of its first full year results as a listed company, due on Thursday, there seems to be a divergence of opinion on the Royal Mail.
On the positive side of the fence is Berenberg's Matthew O'Keeffe, who has just issued a buy note with a price target of 700p. As a reminder the company controversially floated at 330p a share and currently stands at 568p, up 2.5p.
Even the most negative commentators have price targets well above October's flotation price.
But first the positive. Berenberg said:
We forecast 2014 revenue growth of 2.4% to £9.50bn (consensus £9.45bn). Our revenue estimate is based on a 4% year on year decline in UK letter and market mail revenues to £4.60bn, which should be more than offset by a 10.8% year on year increase in parcel revenues to £3.30bn. We forecast that General Logistics Services will increase revenues by 7%, contributing £1.60bn to Royal Mail's top line. Consequently, 2014 will be the first year in which the revenue contribution from parcels will be more significant than revenues from letters.
We forecast earnings before interest and tax and before transformation costs of £615m in 2014, some 3% ahead of consensus, which currently stands at £597m.
A purely relative valuation supports 700p per share. We have looked at a range of postal peers, including Austrian Post, bpost (Belgium), CTT (Portugal), DP, PostNL (Netherlands), Singapore Post and UK Mail. The most highly-rated stock within this peer group is also the smallest (UK Mail), and the lowest-rated stock is not much bigger (PostNL). We have therefore weighted our postal peer group by market cap... Whether we look at PE, enterprise value/EBITDA or enterprise value/sales, Royal Mail is trading at a relative discount to its peer group, and if we look at dividend yield it is trading at a premium. At 700p, Royal Mail would be trading more like parity.
Over at Espirito Santo, Alex Paterson is less keen:
Since we initiated coverage on the 5 December, Royal Mail has achieved a positive settlement with the CWU, continued its efficiency programme and reported trading in line with guidance. However, the competitive landscape has intensified significantly, with TNT Post UK rolling out [end-to-end delivery] competition and significant capacity growth, enhanced service and Sunday and evening delivery from other parcel operators.
Whilst we think Royal Mail does have scope to raise efficiency and improve its technology, we are increasingly concerned that the rate of decline in letter volumes will become unmanageable, it will be unable to evolve its parcel service offering quickly enough to maintain market share and the market itself will struggle to absorb the level of new capacity.
Additionally, we expect the government will try to sell at least some of its 30% stake post results and anticipate this will overhang the stock. We therefore cut our recommendation from buy to neutral, decrease our fair value from 635p to 560p and lower our earnings per share forecasts by 25% and 9% for 2014 and 2015 respectively.
And Robin Byde at Cantor Fitzgerald issued a sell note with a 500p target price:
We forecast full year revenue of £9.4bn with an operating profit before transformation costs of £680m. The market consensus range for full year operating profit is £617m to £698m, with an average of £668m. This broad range reflects the high operational gearing of the business and uncertainty over core addressed letter volumes, parcel volumes and prices.
In late March 2014, Royal Mail announced a further round of job cuts, with a further 1,300 to depart. Total transformation costs for the full year were lifted by £70m to £230m. We expect an update on cost cutting and negotiations with the unions.
The dividend payment is a key issue for many investors. Royal Mail has guided to £133m (or 13.3p per share, yield 2.3%) as a final dividend for 2013, payable in July 2014. Market consensus is for a dividend [in 2014] of 21.8p share, a 3.8% yield. We note that historically European parcel companies have offered a 4%-5% yield, in part, to offset the risks to earnings growth from a decline in the core letters business. On the 2014 outlook, we assume Royal Mail will not provide "hard" profit guidance at this stage of the year.
We believe that Royal Mail's earnings are likely to come under pressure due to its uncompetitive cost base, declining core letter activity and pricing pressure in parcels.
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