The Royal Mail share price is rising: should I buy now?

The Royal Mail (LSE: RMG) share price is up about 230% in the past year. Its shares have traded between 151p and 600p during this period. The results released last week were good. Also, some reports suggest that the company will be moved to the FTSE 100 index when the reshuffling occurs next week.

I would like to understand the pros and cons of investing in this company.

Here’s why I think Royal Mail’s share price will rise

Royal Mail’s revenue grew by 17% year-on-year to £12.6bn. I really like the strong growth. This gives me the confidence that the company is moving in the right direction. Also, it has outperformed its previous three-year annualised revenue growth of 3.5%. 

The company is transitioning its business well from mail deliveries to parcel deliveries. Parcels represented 72% of the group’s revenue. It was the first time in the company’s 500-year history that parcels outperformed mail revenue. This, in my opinion, should bode well in the long-term for Royal Mail as it will benefit from an increase in parcels due to the shift to online shopping.

The company’s adjusted operating profits rose 116% year-on-year to £702m. This figure is higher than the company’s guidance when I reviewed the company earlier this year. The Royal Mail segment was solid as it grew 194% year-on-year to £344m, and the GLS (parcel) segment grew by 72% year-on-year to £358m. The management restructuring, which included the axing of 2,000 managerial positions, will help the company save £130m annually.

It has good free cash flows. This is one of my favorite metrics while evaluating companies. This year it had a free cash flow of £800m. This helped the company reduce debt to £457m for the fiscal year 2021, from £1.1bn for 2020. It swung from a net debt position of £46m to a net cash position of £622m for this year-end.

Looking into the valuation, the Royal Mail share price is currently trading at a price-to-earnings ratio (P/E) of 9.64. I believe the shares are trading at a significant discount to their five-year average of 17 (I have included fiscal years 2015 to 2019 for a better comparison due to Covid-19).

Risks to consider

The pandemic has increased online shopping, thereby giving a boost to the company’s earnings. However, the lockdown restrictions are easing, and most of the economy’s sectors reopening could slow down the company’s revenue growth. There is increasing uncertainty in the business environment. The management also has not given revenue guidance for this year.

Royal Mail’s current focus is on the parcel business. In my opinion, there is a lot of competition in this industry. Also, already established players have better infrastructure and are offering good service. Unless the company can match its competitors’ services, it could be difficult for the company to grow its market share.

Taking all things into consideration. I feel that the merits far outweigh the risks of the stock. Particularly, I like the free cash flows and the improved balance sheet. I would consider buying the Royal Mail shares in the coming months.