Can Royal Mail shares soar higher after posting excellent H1 results?

The Royal Mail (LON: RMG) share price is up 10% since releasing encouraging H1 2021/22 results on 18 November. Since then, it’s also announced it will be returning £400 million to investors. £200 million will be paid out as special dividends, with the other £200 million spent on share buybacks.

And at 504p right now, Royal Mail shares are up 21% in the past month, and 70% since this time last year. But they’re still 127p off their five-year high of 631p that they hit on 11 May 2018. And with Christmas deliveries about to soar, it could rise even further.

Royal Mail share price: H1 2021/22 results

Revenue rose 7.1% from £5.671 billion to £6.072 billion year-over-year. On adjusted measures, operating profit hit £404 million, while operating margin rose from 0.7% to 6.7%. Meanwhile, net debt was nearly cut in half, from just over £1 billion to £540 million. Net cash rose from £47 million to £685 million, while its in-year trading cash flow of £298 million has risen by 36.1%. Clearly, this is all excellent news for shareholders.

CEO Simon Thompson said that ‘pandemic has resulted in a structural shift and accelerated the trends we have been seeing.’ He highlighted the move away from letter delivery to parcels in the wake of the Covid-19 pandemic, with Royal Mail domestic parcel volumes increasing by 33% and GLS by 30%. Meanwhile, letter deliveries only rose by 11%, and are still significantly lower than pre-pandemic levels.

Chairman Keith Williams commented that ‘both Royal Mail and GLS will be able to fund their respective investment pipelines from future cash flows and continue to invest in growth, technology, digital services and the environment.’

Special dividend

Williams continued ‘we will return £400 million of cash to shareholders, partly through a share buyback and partly from a special dividend.’ Moreover, the group is returning this money as it believes that it can continue to grow based solely on current cash flow. And after a restructure, the group has saved £56 million in management costs.

And it continues to drive technological innovation and dispose of weaker legacy systems. Last Christmas, the service was unable to cope with the extra demand for parcel delivery while physical shops were kept locked down. This spurrred it to spend hundreds of millions of pounds on upgrades. This worried some investors, who were concerned about the high price tag. But now that the investment is paying off, it’s no wonder the Royal Mail share price is rising. And with the trend to online continuing, Royal Mail is likely to benefit from continually increasing demand for parcel deliveries.

However, Royal Mail does face challenges. The labour shortage is going to make it harder to hire seasonal workers during the crucial Christmas trading period. And with competitors like Amazon offering significant bonuses to new staff, it might find its wage bill beginning to inflate.

In addition, it has struggled in the past with balancing its commitment to universal delivery with profitability. Thompson said that ‘our strategy to rebalance our offering more towards parcels is the right one, and demonstrates the need to start defining what a sustainable Universal Service is for the future.’ It’s likely that agreeing this definition between shareholders, the government and Royal Mail’s board is going to be difficult.

In addition, it faces increasingly stiff competition in urban centres from the likes of Hermes, DPD, and Yodel who can operate with lower margins without being beholden to universal delivery.

Whether the Royal Mail share price continues to surge back to its valuation levels of 2018 is going to depend on it increasing parcel deliveries further. Having already spent the initial outlay, there could be more special dividends in the future. But its competition is likely to become fiercer as well.

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*Based on revenue excluding FX (published financial statements, June 2020).