ROYMF - Royal Mail: Betting On Zero

Summary

• International Distribution Services plc (IDS) published a trading update for its UK business, Royal Mail today and the share price reaction on the LSE was terrible.
• Royal Mail has been on life support from GLS, its international business for too long.
• I believe it is high time for a split of the businesses as Royal Mail will keep dragging down the overall group performance.
• I believe that the short-term cost saving actions proposed by IDS will slow the hemorrhaging, but it will not fix the underlying problems.

International Distribution Services plc published a trading update for Royal Mail (ROYMF) today and the share price reaction on the LSE was sharply negative.

It was down approximately 15% at its lowest point and recovered during the day to close nearly 10% lower. Today’s share price fall is just the continuation of a 50%+ share price decline this year.

Key highlights from the trading update

Royal Mail reported an adjusted operating loss for H1 2022 of £219 million including a direct negative impact of around £70 million from 3 days of industrial action.

The full year estimated loss is expected to be between £350 million and £450 million depending on if customers move their business to other providers due to the expected disruptions.

The Communication Workers Union (CWU) have threatened a further 16 days (about 2 and a half weeks) of strikes in November and December, on top of eight days of industrial action which have taken place or been notified to Royal Mail.

The strikes are expected to disrupt Royal Mail’s busiest season of the year which will include Black Friday and the Christmas shopping period.

We can try linearly extrapolating the potential impact of 24 days of strike to an operating loss of at least £560 million using information from the trading update.

The actual number might be even higher as the November/December strikes are expected to disrupt the most profitable part of the year for Royal Mail.

If the strikes do happen, it will guarantee a loss of business customers for Royal Mail as competitors such as Amazon (AMZN), FedEx (FDX) and DHL have proven to be far more reliable and have been ramping up their presence in the UK.

Is Royal Mail still viable as a business?

Royal Mail has been on life support from GLS for too long. It is high time for a split of the businesses as Royal Mail will keep dragging down the overall group performance.

In July 2022, Royal Mail reported that it was losing approximately one million per day. These figures do not even include the proposed pay deal of 5.5% which was rejected by the CWU.

IDS has not provided its latest net debt position in the October update. It reported a net debt of nearly £1 billion in May 2022.

I believe its ability to continue financing this net debt position will be dependent on its continued access to the debt markets.

In a rising interest rate environment and increasing macroeconomic uncertainty in the UK, it will be become increasingly difficult to borrow money as a loss-making business.

Deteriorating economic conditions, increased competition in the UK parcels sector and the potential impact of industrial action have fragilized Royal Mail.

The combination of events also raises some serious questions about Royal Mail's future viability.

I believe that the short-term cost saving actions proposed by IDS will slow the hemorrhaging, but it will not fix the underlying problems.

We can hope for a one in a million turnaround, but it is extremely unlikely to happen.

Hopes of re-nationalization have also been quashed due to the recent political turmoil caused by a lack of fiscal discipline from the UK government.

I also do not think there will be many buyers queueing for a business with a heavily industrialized workforce losing a million pound a day!

Conclusion

GLS is a great business with strong potential however the group’s overall financial performance is being dragged down by Royal Mail. Unless management are able to sell Royal Mail, I would not advise investing in the stock. A short position could also be lucrative in the current macroeconomic environment.

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