Royal Mail shares: where are they going next?

Key points

• Short-term cost-cutting may negatively impact Royal Mail shares
• Parcel service suffered a 7% year-on-year decline in the fourth quarter of 2021
• Royal Mail has historically strong earnings and revenue 

A quintessentially British establishment, the Royal Mail Group (LSE: RMG) is a major postal carrier operating around the globe, with well-known subsidiaries, like Royal Mail and Parcelforce Worldwide. The shares have been volatile as of late. 

Royal Mail shares jump prematurely on trading update

On the release of the latest trading update, on 25 January 2022, Royal Mail shares jumped about 6%. This was likely in response to the news that revenue for the three months up to 31 December 2021 was up 17.1% compared with the same period in 2019. This market excitement quickly faded, however, and shares are down 5.4% since that intraday high of 460p.

On closer inspection the update was not as positive as a first glance might suggest. The company announced cost-cutting measures and it plans to lose around 700 manager-level employees. This will come at a cost of £70m. JP Morgan warned in January 2022 that while these cost-cutting measures should save money in the long term, it may result in operational cost and negatively impact Royal Mail shares.

Indeed, the domestic parcel service segment suffered a 7% year-on-year decline, owing to fewer parcels being ordered as the world reopens from the pandemic. The poor reopening performance contrasts with other sectors, like airlines. Furthermore, Royal Mail Group lowered profit guidance for the 2022 fiscal year from £500m to £430m. For me, these all feel like warning signs.

Some reasons for optimism

While revenue for the fourth quarter of 2021 was down 2.4% from the same period in 2020, it is still up an impressive 17.1% on a two-year basis. In addition, recent negative news may be balanced with Royal Mail’s longer-term performance.

The company’s earnings-per-share (EPS) have increased by around 18% between the fiscal years from 2017 to 2021. This consistent growth over an extended timeframe certainly attracts me to Royal Mail shares. Indeed, Bank of America maintained the company’s ‘top pick’ status, owing to the strong performance of freight markets throughout the last two years.   

Although the 2021 fourth-quarter revenue showed a decline, longer-term revenue figures paint a different picture. Reporting £9.7bn revenue in 2017, this has grown to £12.6bn in 2021. What this means is that the average annual growth rate in Royal Mail revenue sits at about 5.3%.  

I find Royal Mail Group an attractive long-term investment. This is based on its strong earnings and revenue record. As we emerge from the pandemic, though, there are a couple of aspects that I find concerning. The cost-cutting measures could be expensive in the short-term and this could negatively impact the share price. The lowering of profit guidance, as mentioned in the most recent quarterly report, is also likely to dent Royal Mail shares. Long term, I think this stock will perform well, but I’m waiting for short-term issues to subside before I think about buying.