When I think of postal and delivery service provider Royal Mail (LSE: RMG), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Legacy postal business.
Royal Mail’s growth potential is indelibly stamped on the parcel delivery arm of its operations. No wonder, in a recent management statement, revenue from parcels increased 8% over the year-ago figure, whilst revenue from letters declined by 3%, continuing a long-term downward trend.
That’s a problem. The further that decline goes, the less economic the letter delivery service is likely to become. When the decline breaches critical mass, costs will likely spiral upwards and become a real drag on the profitable parcel delivery side of the business.
We don’t know how far demand for letter delivery will decline, or whether it will eventually plateaux, but we do know that Royal Mail is obliged to continue the service. The firm must deliver mail to every UK address every day if required and has to go to great lengths to deliver letters to remote and isolated communities. That’s expensive, and Ofcom is watching.
At the moment, there’s no option for Royal Mail to divest its letter delivery service in the way that other firms can sell off non-profitable or contracting parts of their businesses. At the last count, letter delivery accounted for about 49% of the firm’s revenue, and falling …
2) Inherited public-sector culture
Throwing off the shackles of public-sector culture is likely to be an expensive business for Royal Mail. The firm’s essential drive for efficiency involves restructuring costs that may continue for some time. In a recent move, the company proposes a net reduction of 1,300 mostly management positions and expects the cost to be around £100m. The target is some £50m or so in annualised savings.
Total restructuring costs for the year will now be around £230 million, but what about next year. A move to the private sector, especially by such a well-loved and venerable old institution, is likely to be a bumpy ride for some time, and costly.
What now?
Despite such concerns, Royal Mail is transforming its culture and operations to compete, and that’s attractive.