Royal Mail gets thumbs up from HSBC with “overweight” rating
Royal Mail has laid strong foundations through its modernisation programme and can still deliver growth, according to a research note released by HSBC Global Research.
The bank is initiating the company at "overweight" with DCF-driven target price of 710p.
Since the Royal Mail's IPO it has significantly more flexibility to head off volume decline. the reduction in the workforce will also help Royal Mail keep costs under control.
The group has been further boosted by its European parcel operator GLS.
GLS is enjoying margins of 6.9 per cent for 2014 and is increasingly becoming a source of growth opportunities. In the future HSBC believe GLS could be spun off separately or be sold to a global integrator.
Ongoing investment in IT combined with potential investment in new parcel sorting equipment as well as productivity improvements could help the group to hold back cost base inflation.
The regulatory environment has also been favourable to the company, with only five per cent of total revenues subject to a price cap.
While Royal Mail volumes are falling by 4-6 per cent but parcel growth of five per cent and pricing flexibility will be able to compensate for falling volumes. HSBC estimates Royal Mail can still deliver revenue growth of two per cent. While ecommerce continues to grow strongly, mail still represents 60 to 70 per cent of of total revenue national postal operators.
The costs of modernising the company are declining and now that Royal Mail's pension deficit has been offloaded significant cash flow is being generated.
However, Royal Mail is facing stiff end-to-end competition. TNT Post UK accounts for 20 per cent of volumes for Royal Mail and is rolling out an end-to-end network. HSBC believe that TNT's current end-to-end network ambitions extend to six per cent of Royal Mail's volumes.
Royal Mail has responded to this challenge by changing its access pricing to halt cherry picking of of densely populated areas. HSBC conclude that the company's strong cash flow was its primary attraction. Like many other postal companies the key risks to the group remain growing end-to-end competition and rapid male declines.