UK Markets close in 31 mins

Why the Royal Mail share price is smashing the FTSE 100 this year

Roland Head

Shares in the UK postal operator Royal Mail (LSE: RMG) have hammered the FTSE 100 so far this year, climbing 28% during a period when the big-cap index has fallen by 3%.

Of course, such short-term movements aren’t especially significant. Looked at over the 3.5 years since the postal group’s flotation in 2013, both investments are up by around 10%. Despite this, I believe this 500-year old firm is in a good position to face the future and deserves closer attention from investors.

I’ll come back to this in a moment, but first I want to look at a faster-growing alternative investment in the same sector.

A modern business

One of the challenges faced by Royal Mail has been to adapt to a huge increase in parcel volumes from internet shopping.

One company that’s benefited from this change is Leeds-based Clipper Logistics (LSE: CLG). This £441m firm provides logistics services to the retail sector, specialising in e-commerce. Existing customers include ASOS, Sainsbury’s, John Lewis and Superdry.

Clipper shares edged higher today after the firm announced a new contract to run a 600,000 square feet warehouse for Boohoo.com subsidiary PrettyLittleThing.com. This brand is a big player in the youth fashion market and is growing fast — sales rose by 228% to £181.3m last year.

Clipper will handle goods from a range of suppliers and provide fulfilment services for online orders. It’s a big win for the firm and will require 1,200 new staff, increasing existing headcount by more than 25%.

A smooth delivery

Clipper already has a strong track record of growth.  Revenue has grown by an average of 15% per year since 2012, while operating profit has risen at a compound average rate of almost 22% each year.

The group’s operating profit margin of about 5% is good for this sector. And last year’s return on capital employed of 34% suggests to me that this is a very well-managed business, as it implies that the company made £34 of operating profit for each £1 invested in its operations.

An increasing level of scale and automation is required to compete in retail logistics. I think Clipper’s growth is likely to continue — a view shared by City analysts who expect the group’s earnings to rise by almost 25% this year.

Although the stock looks pricey on 28 times forecast earnings, this multiple could soon fall. I’d continue to hold and would buy on any short-term dips.

Why I’d still buy Royal Mail

The shares aren’t quite the bargain they were towards the end of last year, but I believe Royal Mail still offers good value for investors looking for reliable long-term income growth.

Chief executive Moya Greene surprised markets recently when she announced plans to leave. But Ms Greene’s time in charge has been well spent. She’s managed a successful privatisation and strengthened the group’s finances. She’s also reached new deals on pay and pensions with unions, increased automation, reduced headcount, and positioned the group for a parcel-led future.

Analysts expect earnings to be broadly flat over the next year or so, suggesting that the forecast P/E of 14 may be high enough. That may be true for now, but I feel Royal Mail’s strong free cash flow and 4.1% yield mean that the shares are still worth buying.

More reading

Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo.com and Superdry. 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.