The Royal Mail (LSE: RMG) share price is up by nearly 19% as I write, despite the company warning that the core Royal Mail business “will not become profitable without substantial business change.”
So what’s going on? I think today’s share price gain reflects strong trading in the GLS (Parcelforce) business and market hopes that Royal Mail’s management will be able to negotiate a way forward with unions and the postal regulator.
The parcel problem
The coronavirus pandemic has accelerated the shift from letters to parcels. Royal Mail’s parcel volumes rose by 34% over the last five months. That’s an extra 177m parcels compared to the same period last year.
Letter volumes continued to collapse and were 28% lower than last year. That’s 1.1bn fewer letters.
The problem is that Royal Mail isn’t set up to handle this mix of items. Although postal revenue rose by £139m over the last five months, costs rose by £85m. In addition to this, Royal Mail also reported an extra £75m of costs related to Covid-19.
The numbers don’t add up. Royal Mail appears to have too much letter capacity and not enough parcel capacity. Management says it’s struggling to agree much-needed changes with unions, including the roll-out of new parcel hubs and the removal of surplus letter-sorting machines.
Royal Mail share price could be rising on GLS sale hopes
The performance of parcel operator GLS was much stronger. This firm operates as Parcelforce in the UK but also trades in much of Europe and the US under different names.
GLS says parcel volumes rose by 19% over the last five months, with a corresponding 18.6% increase in revenue. Unlike Royal Mail, GLS remained profitable, with an operating margin of 8.1%. That compares to a figure of 6.6% over the whole of last year.
Royal Mail and GLS don’t seem to have much in common. One possibility is that GLS could be sold. This division generated an operating profit of around £208m last year. Right now, I think GLS probably accounts for a significant chunk of Royal Mail Group’s £2.0bn market-cap.
However, I suspect that selling GLS could attract opposition from unions and politicians. Shareholders might not see much of the cash either, due to the ongoing costs of Royal Mail’s turnaround.
Here’s the good news
Royal Mail Group is in a difficult situation. But I think the good news is that there’s money on the table. Parcel volumes aren’t going to disappear and the group’s research suggests that customers want to be able to use Royal Mail’s universal service for their parcels.
The challenge for the group is that it has to restructure its network and operations to support higher parcel volumes and lower letter volumes. This will probably involve some major changes to staff working practices.
Royal Mail’s share price has now risen by more than 70% from the lows seen earlier this year. Despite this, I continue to think the stock probably offers long-term value. GLS helps to underpin the group’s valuation, while Royal Mail also has a £2bn property portfolio.
I reckon the UK’s 500-year-old postal service should be able to adapt and evolve to meet modern needs. But this may not be quick or easy to achieve. I see Royal Mail shares as a long-term buy only, at current levels.