Investment Analysis: The Royal Mail IPO

Royal Mail
Royal Mail

The Royal Mail IPO has caused a lot of stir over the past couple weeks. Investors were forced to accept only £750 worth of shares due to over subscriptions and the share price for $RMG rose over 50% in the days after the IPO.

A look at Royal Mails’ fundamentals
The Government has been looking to sell the Royal Mail group for a while. It has been a drain on public finances and it has been believed that the group could be run better in the hands of private investors. But if the Government is selling off Royal Mail due to inefficiences and it ‘being a drain on finances’ then surely Royal Mail is a bad company to invest in? I took a look at some key fundamentals on $RMG’s annual report (pdf):

EBIT (Earnings before Interest and Tax)

(£m) March 31st 2013 March 31st 2012
EBIT 367 277

EBIT is an important measure, as it takes the amount of money the company makes in ‘accounting’ profits before interest and tax is paid. As interest is tax deductible it makes sense to focus on the EBIT, as it gives a better account for how much money is available for the stakeholders in the business.

I.e. by increasing the amount of interest on debt a firm pays, the firm pays less tax (as interest is tax deductible) allowing more money to be available for all stakeholders (bondholders & shareholders etc).

Cash Flow

(£m) 2013 2012
Cash and cash equivalents at end period 351 473

I’ve looked at the Cash flow statement ending 31st March, as I feel this is an important measure. It is a well-known accounting fact that companies go bust because of lack of cash, rather than lack of profit. If a company cannot pay its liabilities it will simply not function, therefore its satisfying to see that Royal Mail has a healthy and positive cash flow – as shown in the table above.

Interest Cover

 Interest-cover-RM

Leading on from Cash Flow I calculated the Interest Cover above. This gives a view on the  liquidity of the business and the ability for Royal Mail to pay back its debts. At a healthy 3.49 times this is also a good figure for shareholders.

Gearing

Gearing-RMThe Gearing test helps us identify how much debt the company has taken on. Anything over 50% should be viewed with caution, as it raises the risk of insolvency due to the inability to pay the businesses’ debts. At 58% I would not be overly worried about this ratio.

N.B. The Capital Employed calculation is not taking into account current shareholder funds – as they were not available in the financial statements year-ended March 31st – had the calculation taken into account these funds, the gearing would be lower.

Acid Test

PNG-acid-test-RMThis is a measure of liquidity, which helps us identify any issues Royal Mail might be having. At a quite low level of 0.748:1 I would expect Royal Mail to maybe reduce it’s current liabilities and make better use of its current assets to help bring it to a more healthy level of 1.5:1.

Pension
Royal Mail has had a well-known reputation for holding one of the most poorly run pension schemes in a large UK Corporation. Pension liabilities have ranged from £2.7 billion to £7.5 billion, at some points questioning Royal Mail’s solvency. However in 2011 the Government passed the Postal Services Act allowing Royal Mail to pass over its pension liabilities to HM Treasury. Now, as reported in March 2013, Royal Mails’ pension is a £825 million asset.
This is good news for investors, as it removes any questions of Royal Mail being dragged down by a large pension liability, and also means that the pension is backed-up by the Government, providing extra security for investors.

What does this all say?
With my biggest concerns about Royal Mail being in its ability to pay its debt and with the Pension Liabilities, this analysis has proven that Royal Mail would be a good investment. It is able to cover its interest quite comfortably (3+ times) and the pension liability has been practically completely removed by HM government.

With a dividend due in next March, of around 6%, this also places Royal Mail at the top of the list for income-seeking shares. N.B. it must be noted that the yield of $RMG is now only 3.9% at the higher price of 500p a share.

So why was the company IPO under-valued?
Well, that is the question indeed. The IPO was valued at 330p, but shares in $RMG are now hitting highs of 500p – surely the government took a look at the subscription rates for shares, and the fundamentals, and realised that the company should be worth more? This has certainly caused a debate in the financial world (reuters).

If it was the case that the government purposely undervalued Royal Mail, my opinion is that by allowing private investors to benefit from the Royal Mail undervaluation it might encourage more investments into the stock market from individuals, which would be a positive thing when QE looks like it could be tapered off over the next couple years and when it could be argued that an increase in market confidence might help the economy grow.

Furthermore the rise in the share price from the IPO could create a multiplier effect throughout the economy, as individuals feel wealthier from the IPO or sell their shares and spend the money.

In addition, with taxpayer’s money no longer being used to prop up Royal Mail (with exception to the pensions) it can now be used more wisely elsewhere, in areas such as healthcare and education improvements. I also believe it would have been devastating, not only for the government, but also for the economy and the private individuals who bought the shares, if the IPO had been a failure. The result of a failed IPO would have been quite a downer on the UK Economy, especially when there aren’t that many good IPO stories since pre-Facebook IPO. It’s also quite a nice feeling when the small investors (students and grandparents alike) get the priority and benefits from these offerings, as opposed to the large institutional players.

Did you buy Royal Mail, or did you miss-out? Were you a straight seller, or are you holding in for the dividend? Let me know your thoughts @Breadeconomics.

-Ed

Investment advice in this blog is informative and is not liable to any decisions made by the reader.

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s