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IDS share price is rising: here’s why Royal Mail is still uninvestable

The International Distributions Services (LON: IDS) share price has made a slow recovery in the past few weeks. Shares of the Royal Mail parent company rose to 255p on Wednesday, which was ~42% above the lowest level. Still, there are concerns about whether these gains will hold in the long term as the company faces structural issues.

Structural issues continue

The postal industry is an extremely difficult one in an age when letters and cards have lost their significance. A quick look internationally shows that postal companies that dominated in the past have either collapsed or are on the verge. For example, in South Africa, the company was recently placed in administration.

The same trend is happening in the United States, where the USPS only exists because of government funding. In 2022, the company lost over $423 million after losing over $4.9 billion in the previous year. The losses narrowed because of the government’s pandemic bailouts. 

In the UK, Royal Mail is equally facing these challenges as the volume of letters plunges. According to Ofcom, the volume of letters sent in the UK dropped by 225 in 2021.They have dropped annually in the past few decades. It is hard to expect that the volume of letters and cards will grow in the future.

The most recent results showed that Royal Mail’s letter revenue dropped by 6.1% to £2.6 billion in the fist nine months of the year. 

As a result, successful companies are those that pivoted to the parcel industry as e-commerce businesses bounced back. The challenge with the parcel industry is that it is highly competitive, with newer well-funded startups offering better services. The recent results showed that Royal Mail’s domestic and international parcels revenue dropped by 19% and 12%, respectively.

Restructuring is urgently needed

The reality is that Royal Mail needs deep restructuring for it to continue as a going concern. Precisely, it needs three main things. First, the company needs to restructure and reduce the size of its workforce. The company has over 162k employees, making it one of the biggest employers in the UK. I believe that these are way too much people for a company that is staring at bankruptcy.

In contrast, USPS has over 516k employees while generating over $78 billion in annual revenue. Deutsche Post, on the other hand, generated over 94 billion euros in total revenue with over 565k employees. This means that Royal Mail is making less money per employee.

Implementing these structural issues is not easy because of the power of Royal Mail’s unions, who have been protesting in the past few months. These employees argue that their wages have not grown substantially. 

They also blame the company for paying huge dividends and even spending millions acquiring Rosenau Logistics during the pandemic boom. As I wrote last week, some employees believe that putting the company into administration will be a good outcome since it will take it back to government ownership.

Government policy change needed

Royal Mail, as a former government agency, is still suffering from inefficiencies that existed back then. For one, it is mandated to deliver to all people in the country from Monday to Saturday. This means that it must deliver even the most unprofitable areas. Further, the company cannot just hike delivery fees as other private sector companies do. 

Therefore, these challenges mean the company’s future profitability will be much lower as the volume of letters is expected to drop in the next few years. This challenge can be solved if the government changes its policy, which is highly unlikely.

So, what is the future of IDS? One of the likely solutions is where the company decides to spin off Royal Mail and GLS. For many years, GLS has done well subsidizing Royal Mail. Despite having less revenue, GLS is usually more profitable than Royal Mail. In the most recent earnings report, the company said:

“Ongoing industrial dispute further increases the risk of impairment of the carrying value of the Royal Mail cash-generating unit (CGU)2 , which was £1,412 million at 25 September 2022. Any impairment charge would be classified as a non-cash specific item.”

Further, the company needs a steady stream of income to deal with its pension liabilities, which are worth over 11 billion pounds.

Therefore, the recent recovery of the Royal Mail share price should be taken with a grain of salt. As I wrote in this article, I suspect that the shares will have a bearish breakout in the coming months as the company’s outlook darkens. A deal with unions will also not be a positive catalyst for the company since structural challenges remain.

The post IDS share price is rising: here’s why Royal Mail is still uninvestable appeared first on Invezz.

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