An international buy – UK’s Royal Mail

Chairman, Wilson Asset Management
Print This Post A A A

Investors have generally done well by buying companies from governments that move to a publicly-listed environment. The reasons are:

  1. Firstly, the government is politically incentivised to make investors happy with the deal, as they are generally voters and those taxpayers who are selling their assets cheaply, don’t feel the negative effects of their side of the deal;
  2. Additionally, the government wants to be able to do more deals in the future and knows that setting a precedent will ensure an easier process next time; and
  3. Finally, there is the compelling reality that companies run under private ownership are operated more efficiently than those owned by governments. Therefore, a company is likely to perform better post a float and this isn’t usually fully priced into the issue price.

Unfortunately for us, these deals don’t happen that often in Australia. Telstra (T1) was a cracker, CSL Limited (out of the CSIRO) is one of Australia’s best performing companies and, more recently, QR National (now Aurizon Holdings Limited) has also delivered.

It’s in the mail

Well, for globally focused investors, the fiscal challenges of the UK Government have delivered a similar situation to T1. The Royal Mail IPO was priced at just £3.30, and after just one day of trading last Friday, had risen 35% to £4.46.

It certainly looked compelling value at the IPO price of £3.30. While the accounts are a little messy, the numbers look something like this: historical price earnings (P/E) ratio circa eight times and forecast yield of 6% per annum. If we annualise the first quarter result for the current 2014 year, we get a P/E around six times. (I have backed out the transformation costs). By way of comparison, Deutsche Post trades on a P/E in the mid teens and a yield under 3%.

Royal Mail is run by a Canadian woman, Moya Greene, who has a solid track record, having run Canadian Post. She delivered aggressive restructuring and increased productivity during her tenure in that role. Greene took on the Royal Mail role a couple of years ago and has been busy focusing on productivity improvements, having spent over £400m in “transformation costs”. My view is that any organisation such as this that has been owned by the government for hundreds of years has a great deal of scope for cost cutting and productivity improvement. The same process at Telstra is still going on.

Royal Mail staff are being gifted a large amount of stock to create a positive incentive to improve the business too.

Let’s go shopping

The business is basically leveraged to two trends: a gradual contraction in letter volumes and secondly, a growing parcel delivery business both within the UK and across Europe. The business therefore is a proxy for increasing volumes in online shopping (a trend I’m comfortable with), while traditional letter volumes will continue to decline.

The outlook for productivity gains over the next few years and the attractive valuation suggests the stock could be a good multi-year investment. While the stock has initially soared beyond the IPO price, in a pullback, we see value in it at a price of up to £4 per share.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report:

Also from this edition

View More Articles