Royal Mail

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 2/5

A UK-based postal and delivery service provider navigating a challenging industry landscape with a focus on efficiency and modernization.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Royal Mail’s business is heavily influenced by the evolving postal market dynamics, rising costs, and its ongoing transformation efforts. It’s important to note that its international GLS division is generally better performing than its UK operations.

Business Overview

Royal Mail, operating as International Distributions Services (IDS), is a postal and delivery service primarily operating in the UK, under its Royal Mail brand. The company’s operations include collection, sorting, and delivery of letters and parcels. It also has an international business through its GLS division, which offers parcel delivery services across Europe and North America.

Revenue Distribution: The company has the following segments:

  • Royal Mail: Primarily domestic letter and parcel delivery. While it has a large infrastructure and network in the UK and an almost universal service obligation for postal delivery, its profits are constantly under pressure with volumes shrinking due to increased digital communication alternatives and increased competition in delivery business.
  • GLS: International parcel and logistics provider operating in Europe and North America. This part of the business is considered very profitable and has been growing over the years.
  • Other: Other divisions of the company not categorized in the previous two segments.

Industry Trends:

  • Decline in Letter Volumes: The traditional letter delivery business is facing significant declines due to the shift towards digital communication, putting immense pressure on Royal Mail’s UK operations.

The declining letter volume is a secular trend and a major headwind for Royal Mail.

  • Growth in Parcel Delivery: E-commerce has fueled the growth of parcel delivery, which provides a potential upside for the company’s delivery business. However, there’s also lots of competition in this area, which increases pressure on prices and margins.
  • Competition: The postal and delivery industry faces intense competition from both traditional postal operators and newer, more nimble logistics companies. This is especially in the UK for its core operations.

Margins:

  • The company’s UK margins remain under pressure due to falling revenues and increased costs, and the need to overhaul its old-world, cost-intensive structures.
  • GLS boasts significantly better margins due to higher prices and growth opportunities.

The divergence in profitability between Royal Mail and GLS highlights a fundamental problem in the business.

  • Recent performance suggests that margins will continue to face pressure in the short term due to costs associated with the transformation and business changes.

Competitive Landscape:

  • In the UK, the delivery sector is highly competitive with many players. Newer operators have a cost structure advantage and are competing to grab a bigger piece of the pie.
  • Internationally, GLS faces competition from large, well established logistical companies as well as newer, agile firms and this can be both fragmented (in some parts of Europe) and concentrated (in North America).
  • The industry has been undergoing rapid consolidation, particularly in the logistics sector, in the past few years.

What Makes Royal Mail Different:

  • Universal Service Obligation (USO): In the UK, the company has a unique regulatory obligation to deliver mail to every address in the UK, six days a week. This comes with a financial burden, especially in remote areas where delivery costs can be high.

The USO is a unique moat in a way- but it is more like a burden on profits, than a positive thing.

  • Extensive Infrastructure: Royal Mail has a vast network and infrastructure in the UK, however this is not much of an advantage as it is costly to maintain and not adaptable to newer market conditions.
  • Established Brand: The Royal Mail brand carries strong recognition in the UK, but also associations with its past inefficiencies and slow processes, so it might be a net negative.

Financial Analysis

Recent financial results are more important than historical results. Focus on the trends that are likely to persist, and use that to analyse the business.

Latest Results (2023-2024):

  • The company delivered a weak operating performance, with underlying performance below even adjusted expectations, though management pointed to cost improvements by the end of the year.

  • While GLS continued to grow, Royal Mail’s domestic operations reported a significant loss, driven down by lower than expected revenues and the ongoing need for transformation investments.
  • Revenue in the UK was depressed because of a combination of the industrial action and lower volumes.

The UK operations continues to be a drag on the business and its future profitability is uncertain.

  • The company continues to implement cost efficiency programs to deal with the lower revenue situation and increased competition.
  • One time cash costs of around £140 million were related to transformation programs, specifically related to the voluntary redundancy scheme and an associated one off write down to make it future ready, and to restructure delivery operations.
  • Management stated that they are going through a multi year transformation.
  • They anticipate increased cost pressures in the medium-term related to the labour market and inflation, impacting margins.

Balance Sheet:

The balance sheet reflects a relatively weak financial position with significant leverage and potential issues in liquidity.

  • High debt levels: The company has a substantial debt burden that has increased after its restructuring and transformation programs.
  • Pensions liability: There are significant pension liabilities on the balance sheet that are weighing on the company.
  • Intangibles: A large portion of assets are made of intangible assets, including goodwill from various acquisitions.
  • The net assets are lower than the debt owed, and that is not a good sign.

Moat Analysis: 1 / 5

  • Royal Mail has a very narrow moat, which primarily comes from its Universal Service Obligation (USO) in the UK.
  • However, this is being increasingly rendered irrelevant due to the rapid change in the mail and delivery industry.
  • The company faces competition from better positioned, new-age logistics providers, that have a lower cost structure and better processes.

The competitive landscape makes it extremely hard for the company to maintain a high level of profitability in the long term in its UK operations.

  • The international GLS business has a strong moat due to large presence and delivery networks but these are also being challenged by competitors.

Risks to the Moat and Business Resilience:

  • Technological Disruption: New delivery methods and technology improvements, as well as increased digitalization, can disrupt its operations, which are not very flexible or agile.
  • Increased Competition: As the industry becomes more competitive, increased price pressures can erode both profitability and market share.
  • Uncertain Outlook for the UK Operations: Ongoing secular trends, such as the decline in letter volumes and the burden of the USO, have a large negative impact on profitability of the UK operations.
  • Macroeconomic Factors: General economic slowdowns or recessions can affect business volumes and therefore the company’s revenues.
  • Operational Issues: Failure to correctly transform and upgrade operations could lead to increased costs and operational inefficiencies.

The high debt levels, the decline in the mail sector, increased competition in the delivery sector as well as regulatory uncertainties leave this company in a very dangerous state. Its future success is highly dependent on its management’s ability to turn around the UK operations, which is not a guarantee in its current state.

Understandability: 2 / 5

  • The core business model of postal and parcel delivery is relatively easy to understand, and the GLS part of the business is also reasonably easy to grasp.
  • The complexities arise from the detailed financial reporting, accounting for the USO, the pension obligations, accounting for acquisitions, and a detailed study of its business and operations. Also, its relationship to the UK government adds more complications to the analysis.

Overall, although the core business is easy to understand, the full complexities of the finances and its many divisions add some difficulty to understanding the overall business.

Balance Sheet Health: 2 / 5

  • The company has a very high debt load, mostly because of its transformation efforts and investments in the business.

This is the greatest risk to Royal Mail at the moment.

  • It also has a large unfunded pension liability, and a heavy reliance on intangible assets.
  • Overall, the balance sheet isn’t healthy as assets and liabilities are not well balanced, the company needs to prioritize deleveraging to improve its overall financial health.