Liberum reiterates rating on Royal Mail

Following a lengthy dispute over pay and working hours, Royal Mail finally reached an agreement with unions last December. As well as a pay rise, the deal includes a one-hour reduction to the working week, from 38 to 37 hours, to come in by October 2021 at the latest.

Liberum analyst Gerald Khoo said: "We believe the market is underestimating the challenge of offsetting the forthcoming one-hour reduction.

"The last such move, in October 2018, was the catalyst for a collapse in profits that has only been arrested by the pandemic parcel surge. While the latter has given Royal Mail breathing room, we await details of how management intends to deliver rapid and unprecedented improvements in productivity to offset the next working week cut."

Khoo said the previous reduction had required a 2.5% improvement in productivity to neutralise its impact.

"However, there was also underlying cost inflation to deal with. Not only was the required 4-5% improvement in productivity beyond what the UK division was capable of achieving, but also achieved productivity fell close to nil. Profits collapsed, even as revenue continued to grow."

Khoo concluded: "For now, Royal Mail is firmly in an earnings upgrade cycle driven by parcels volume strength and a moderation in the decline in letters volumes, relative to the extreme levels seen during the early phase of the pandemic.

"However, comparatives will be extremely tough in 2022. “We raise our forecasts for 2021 to match consensus and guidance, but our estimates for later years remain below consensus."

Royal Mail is due to publish full-year results on Thursday, and is set to provide an update on its UK operations alongside the numbers.

Khoo said: "We are most keen to understand how management intends to offset the productivity headwind created by the agreement to shorten the working week.

"Additionally, we expect an update on the new major automated parcel hubs, progress towards parcel sorting automation in the traditional network, productivity improvement initiatives, and measures to improve employee relations."

Liberum increased its price target on Royal Mail shares to 560p from 480p.