Panmure Gordon was widely quoted with its pre-IPO pre-initiation note which suggested Royal Mail was undervalued by over £1bn. Since then it has had time to conduct a more through review with analyst Gert Zonneveld explaining:
“The exceptional attractiveness of the IPO prompted us to rush into print with a pre-IPO pre-initiation note. Now that the dust has settled we have been able to carry out a more thorough review. Despite the strong share price performance since listing, we believe there is still meaningful upside potential on a 12 month view and beyond. We initiate coverage with a buy recommendation and 570p target price.”
Zonneveld further added:
“The new regulatory framework (from March 2012) gives Royal Mail significantly greater commercial freedom to set prices for its services. Access mail, which used to be significantly lossmaking, became profitable last year and, with only 5% of revenues under direct price control (was 60%), Royal Mail should have sufficient operational and pricing flexibility to achieve the 5%-10% earnings margins on the reported business which Ofcom considers a reasonable return.
Targeted productivity improvements of 2%-3% per annum should help contain cost increases. Even though the key elements of the programme should be substantially completed by the end of 2013/14, we expect further improvements in terms of mail centre rationalisation, walk sequencing, handheld scanning and delivery office modernisation. From next year, the focus is expected to be on ongoing network optimisation, fleet investment, technology investment and automation evaluation.
Risks such as e-substitution and competition remain, but in the current regulatory regime Royal Mail is better equipped to manage these risks and achieve good profitability.
Cash generation should be strong, particularly once transformation related outflows decelerate. Including potential property disposals (three key London properties could generate over £330m) the company could have net cash at the end of 2015/16 (net debt at the end of June 2013 of £796m).”