Is Royal Mail’s FTSE 100 Status In ‘Danger Zone’ On Blue-Chip Reshuffle?

Royal Mail Plc, which traces its origins back five hundred years has been a member of the FTSE 100, the UKs index of blue chip companies, since shortly after being privatized in 2013, only narrowly escaped relegation in the most recent quarterly review this June. But could it now be relegated? Some pundits have ventured as much.

Todays British postal that was founded in 1516 when Henry VIII created a Master of the Posts was the darling of the stock market following its full privatization in 2013 and debut on the London Stock Exchange.

But after shares reached the giddy heights of £6.15 in January 2014 concerns have grown about its speed of restructuring, falling letter volumes and on-going negotiations with unions around closing its expensive Defined Benefit (DB) pension scheme.

These worries have contributed to the shares falling to £3.97 a pop of late, which equates to a decline of 20% year to date. And, since hitting the highs back then the share price drop equates to c.35%.

David Jinks, Head of Consumer Research at ParcelHero, a parcel broker that partners with major courier operators DHL and UPS, commenting said: Royal Mails market capitalization is now hovering the around £4 billion (bn) level. And, since its flirtation with relegation in June, its shares have dipped below the talismanic £4.00 figure for the first time.

While there is more to the calculation of who is relegated than simple market capitalization, it is significant that of all the FTSE 100 companies, only embattled Provident Financial, which was forced to issue a fresh profits warning this month and has a far lower market cap (£1.18 billion (bn)).

Following Royal Mails relegation escape in June, its eventual demotion to the FTSE 250 has continued to be predicted by industry experts in the Financial Times and elsewhere.

Analysts became increasingly pessimistic after UBS added Royal Mail to its Sell list last month on July 7. The broker claimed there is a lack of automation and slow progress with restructuring, making Royal Mail relatively expensive for heavy parcels. Further, this is likely to erode the operators share of a deteriorating UK e-commerce market and – because costs are largely fixed – any revenue shortfall is likely to hit profits.

Princess Anne, Princess Royal tours the Mail Rail galleries during her visit to The Postal Museum and Mail Rail for its ceremonial opening on June 13 in London, England.  (Photo: Miles Willis/Getty Images for The Postal Museum)

UBS recommendation was partially offset when HSBC upgraded its rating on for stock from a Hold to a Buy on July 31, stating that the valuation was compelling – notwithstanding risks involved in holding the shares.

While the broker noted issues around industrial relations uncertainties and weakness in its delivery volumes had weighed heavily on share price performance, it contended that the risk/reward ratio was favourable at the then current price of £4.00 or around that level.

It also set a 12-month price target of £4.65 a share – 10p less than its previous target. However, this took no account of Royal Mails surplus property, which HSBC estimated at the time was worth 44p a share.

Shortly before the last FTSE 100 culling for the second quarter of 2017, despatches from Forbes, Portfolio Advisor and others warned Royal Mail was in the danger zone for relegation. Jinks has now warned that going in to the next FTSE reshuffle Royal Mail is facing new woes that could have analysts even more concerned.

He said: Shareholders liked its original plans to change its expensive pension scheme, but the Communication Workers Union (CWU) recently rejected Royal Mails revised pension proposals. The CWU now says it will give the privatized postal operator until September 6, 2017 to reach a settlement. That is, of course, beyond the key date of this Wednesday when the FTSE 100 winners and losers are revealed.

It should be noted that the final decision and approval of changes will be announced after market close on Wednesday 30 August  using the market capitalization of companies at close of trading on Tuesday 29 August. Changes will be made effective after market close on Friday 15 September, i.e. from start of trading on Monday 18 September.

Royal Mail wants to replace its DB pension scheme, which guarantees a level of income in retirement, with a less generous arrangement. The company currently pays about £400 million (c.$515m) a year into the pension pot, but says that could more than double to above the £1bn (c.$1.29bn)  mark, if no changes are made. 

Potential Distraction

Perhaps even more significantly for industry watchers, there are rumours that Royal Mails highly regarded Chief Executive, Moya Green, might be facing other diversions. Green was recently appointed to the board of easyJet, a controversial move because of the timing over the pensions row, Jinks posited. Its not only the potential distraction that alarms investors according the ParcelHero executive, who is a Member of the Chartered Institute of Logistics and Transport.

The Daily Mails City pundit, The Dastardly Mr Deedes, has even suggested that, as a former Canadian transport minister with experience in dealing with unruly unions, Green could in fact become the next CEO of EasyJet before long.

Reflecting further Jinks said: Perhaps the main reason Royal Mail is  staring down the barrel of eviction from the FTSE 100 is that Parcel Heros own industry analysis suggested that Royal Mail is falling behind the growth of the parcels industry as whole.

Royal Mail’s core UK Parcels, International and Letters (UKPIL) divisions revenues were actually down 2% last year, while its UKPIL parcel volumes were up just 3%. And, this in an e-commerce market (on-line sales) growing 15.1% according year-on-year and by 0.3% on the month (July), according to the latest retail figures from the Office of National Statistics published this August.

Royal Mail Plcs annual results for the past few years have been stable and consistent. But, bearing in mind the rapid growth of the home delivery market, its parcel volume growth is falling behind that of the overall market. This is in no small part due to Amazon deserting Royal Mail in favour of their own distribution network in order to deliver same day and one-hour Prime services.

Analysts Verdict & Share Price Forecast

The consensus forecast amongst seventeen investment analysts polled who are covering Royal Mail as of August 18, 2017, advised investors to hold their position(s) in the company. And, the latest recommendations at that date on the stock was Buy from two analysts, Outperform (4), Hold (7), Underperform (1) and Sell (3), which was exactly the same position from one year ago.

Recommendations            12 months ago           Latest

Buy                                                          2                                2

Outperform                                           4                                4

Hold                                                        7                                7

Underperform                                      1                                 1

Sell                                                          3                                3

Source: Thomson Reuters (as of 24 August 2017).

While the company reported a dividend of 23p in 2017, which represented a 4.07% increase over the previous year, of fifteen analysts canvassed they expected dividends of 24p for the upcoming fiscal year. At the current share price (£3.96) this would equate to a yield of 6.06%.

Whether that is a tempting enough yield for buying the stock is open to question. The group of fifteen analysts providing 12-month price targets ranged in their forecasts from a median of £4.50, which is 13.2% higher than the current trading price. The high estimate is £5.90, +48.4% over  todays price, with the low at £3.50 (-11.9%).

Its a close call for Royal Mail as to whether they will in fact fall out of the FTSE 100 and not a done deal, but one can at least speculate in the run in to the reshuffle announcement.

Indicative positions on the promotion and relegation candidates provided by the London Stock Exchange as of Thursday 24 August on the promotion and relegation candidates, with the numbers crunched by FTSE Russell. It revealed that one FTSE 250 constituent was eligible for potential entry into the FTSE 100 Index – namely NMC Healthcare, the UAE’s largest healthcare provider, while Provident Financial Group was eligible for potential demotion.

Beyond that, FTSE Small Cap companies or new entrants eligible for potential entry into the FTSE 250 Index included Alfa Financial Software Holdings, 888 Holdings, and Sequoia Economic Infrastructure Income.

Shares in Royal Mail ended this Friday (August 25) a touch down (0.16%/0.64p) at just over £3.95, implying a market capitalization of £4.02bn and on a Price/Earnings (P/E) ratio of 14.44. Its not a stratospheric P/E and seems a reasonable level.

Whatever transpires next week Royal Mail has withstood many challenges in its long history over the centuries and in time its plans to modernise its equipment and practices, which Jinks believes will doubtless come good. That said, it remains to be seen if it will be enough or in time for the next weeks FTSE 100 reshuffle decision.