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Royal Mail shares just tanked. Here’s what I’d do now

Edward Sheldon, CFA
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Yesterday, shares in Royal Mail (LSE: RMG) fell a whopping 14%. The reason? The FTSE 250 company issued a disappointing set of half-year results in which profits were well down on last year.

Here, I’ll take a closer look at those latest results and explain how I’d play the stock now.

Poor half-year results

It’s hard to deny yesterday’s half-year results, which covered the 26 weeks to 29 September, were pretty poor.

While revenue for the period was up 5.1%, adjusted operating profit fell 13.2% and adjusted basic earnings per share were down 18% at 11.1p. In addition, the group’s profit margin declined from 3.9% to 3.2%, its net debt ballooned out to £1,372m from £470m last year, and the interim dividend was reduced from 8p to 7.5p.

Making matters worse, Royal Mail also advised that:

  • Its transformation plan (its ambition is to build a ‘parcels-led, more balanced, and more diversified international business’) is “behind schedule

  • The outlook for the letters business in the UK is “challenging” due to economic uncertainty and lower GDP

  • The industrial relations environment is impairing its productivity improvement and threatening profit margins

  • The business could potentially make a loss in the 2020-2021 financial year

So, overall, revenue growth aside, there weren’t too many positives in those interim results.

My view on Royal Mail shares

To be honest though, I’m not that surprised by the poor half-year results and the subsequent share price fall. That’s because Royal Mail is a stock I have been warning investors about for a while now.

For example, when I covered the FTSE 250 stock in October last year, I pointed out that five analysts (out of 16) rated it as a ‘strong sell’, and I said that, in my view, the stock was “quite risky.” More recently, when I looked at the stock in August, I said that it was one to “avoid.” Today, my view on the stock remains the same – I think the best move is to avoid it.

Yes, the stock looks cheap (the forward-looking P/E ratio is just 10). And yes, it appears to offer a big dividend yield of nearly 7% (although I’ll point out that my colleague Alan Oscroft believes the company cannot afford to pay its current dividend even after the 40% dividend cut last year).

But looking at the challenges the business is facing, I just don’t think the shares are worth the risk. Ultimately, people are posting far less letters these days, which means Royal Mail needs to evolve significantly. That’s going to take time and money.

With six analysts out of the 13 who cover it currently rating the stock as a ‘sell’ (including three rating it a ‘strong sell’), I’m definitely steering clear here. All things considered, I believe there are much better stocks to buy at the moment.

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Edward Sheldon has no position in any 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