International Distribution Services' (IDS) saw revenue down 5.4% to £9.1bn over the first 9 months of the financial year. That reflected a 12.8% decline from Royal Mail that was partially offset by GLS, which rose by 9.7%.
Royal Mail continues to feel the impact of structurally lower demand for letters, with volumes down 25% on pre-pandemic numbers. Parcel volumes also fell, down 20% year-on-year as the group lapped the higher demand seen last year. Compared to pre-pandemic levels, parcel volumes fell 6%.
Over the 9 months, underlying operating losses from Royal Mail reached £295m. The net cost of the 18 days of strike action is being estimated at around £200m.
Royal Mail is on track to deliver a 5,000 reduction in FTE (Full Time Equivalent, a measure of headcount) by March 2023.
GLS revenue growth was driven by higher prices and freight revenue, volumes fell 2%.
At the group level, despite more strikes than anticipated, a full year underlying operating loss is expected in the middle of the existing £350m-£450m range. That's on the basis no further strike action occurs in the fourth quarter.
The shares rose 2.1% in early trading.
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Our View
It's not usually the case that a projected operating loss of around £400m is met with a positive reaction from markets, but such is the state of Royal Mail's parent company, IDS, this could have been a lot worse. Strike actions have plagued Royal Mail over the last year, the 18 days of strikes was 6 more than IDS had originally built into its guidance.
Credit should go to management, though, actions taken to mitigate the impact of more recent strikes have limited the financial impact.
Nonetheless, ongoing disruption has severely impacted the Group's ability to resize its operations in the face of falling volumes.
Until a way forward is found, the outlook appears precarious. At the half year mark IDS had net current assets of just £76m, a key metric of short-term financial health. Even if performance holds up at GLS, the Group's International Parcel Network, it seems likely that IDS will be below cash-flow break even for the current financial year.
IDS' base case projection for the next year suggests it will have sufficient liquidity, although it expects to only have a small amount of breathing room on its loan covenants. These are requirements, set by lenders, around the amount of cash profit generated relative to things like net debt.
It's not surprising then, to see the board suspend the interim dividend. The prospective yield of 6.22% is, in our view, unlikely to materialise. Further time will tell.
Aside from union troubles, the underlying business is also under some pressure. Parcel volumes are down from the booming demand seen over the pandemic and letters have long been in a structural decline. A new 5-point plan was shared with investors at the half year mark, with headcount reduction a focus. There's been some progress already, with half of the planned reduction on track to be delivered by March.
There are some bright spots. We're encouraged that GLS is still growing revenue, and we believe there are some long-term growth opportunities in this division. Keep in mind that broader conditions might create some near-term challenges.
There's also been talk of GLS and Royal Mail splitting, but this is by no means guaranteed. If Royal Mail can return to sustained profitability, it may make sense to keep them together. If it can't, there are real questions as to what an exit might look like.
If IDS can reach an agreement with the Union, resize operations and start the process of returning to profitability at Royal Mail, it's possible the wider group's valuation could re-rate higher. There are, however, substantial hurdles to overcome and investors should proceed with caution.
Royal Mail key facts
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
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