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What I’d do about the Royal Mail share price right now

Conor Coyle
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The Royal Mail (LSE:RMG) share price has tanked in both the long and short term and many investors are beginning to ask the question of whether shares in the company now represent a value investment.

Shares in the mail distributor have fallen around 56% in the last year, while in the last six months alone, their value has dropped 30%.

Earlier this year, new CEO Rico Back announced that Royal Mail would cut its dividend by 40% in order to free up funds to aid its recovery.

That inevitably led to a further sell-off, but with the ultimate aim of making the firm more stable. So where do I think the Royal Mail share price is headed in the coming months and years?

Value package?

Looking at Royal Mail’s current valuation, the company is trading with a P/E ratio of 6.5, significantly below many of its peers in the FTSE 250. That would indicate that perhaps it is undervalued, but with its earnings having been in decline for some time, I wouldn’t subscribe to that view.

Adjusted earnings per share have been on the slide, particularly in its last full financial year, falling to 30.5p from 45.5p  a year earlier. 

In its most recent quarterly earnings report, Royal Mail said first-quarter performance was in line with expectations, but it was hardly an inspiring update with operating profit for the year expected to be between £300m and £400m.

The shares took a further hit last week after analysts from JP Morgan Cazenove noted an increase in tensions between the company and the Communication Workers Union (CWU).

While the union disputes are based on several different issues, part of this is being triggered by Royal Mail’s attempts to bring its processes more in line with technological advances. 

The introduction of digital assistants and new parcel sorting strategies have led to friction among workers, and for me this represents one of the biggest challenges to face Royal Mail and its shares in the coming years.

I’m not convinced that the firm will be able to manage that progression towards more modern practices, without the added angst among workers based on potential staff reductions.

Dividend cut

It must be noted, however, that the board’s move to slash the dividend has positive intentions behind it. The added cash that this will free up should allow for more investment in key services and operations. 

As commented on by Rupert Hargreaves, for too long the dividend was prioritised above all else, even when Royal Mail badly needed investment. With the dividend yield now forecast to be just under 7%, even with the cut, there is certainly enough there to tempt some investors into making a value play on the business.

For me, however, it would be difficult to rule out a further cut to the dividend if earnings continue to fall at their current rate, which is a real possibility.

At its current price of 200p, even with a P/E ratio of just 6.5, I just don’t see enough evidence that Royal Mail can turn its fortunes around. Time will tell as to whether it can reinvest the funds from the dividend cut wisely, but there is little indication of what that will look like at this stage, so I’d stay well away.

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Conor Coyle has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019