Comment: Dividend will make Royal Mail look attractive

IT’S a measure of the chastened times we are in that reaction to the imminent offer for sale of shares in Royal Mail has been subdued and guarded.

Bill Jamieson

The razzmatazz that surrounded the giant privatisations of the 1980s is absent. Too many disappointments, too many stock market slumps and too many reports of privatised utility fat cat bonuses have jaded public ­enthusiasm.

The positives – greater competition, keener attention to customer needs and useful total return gains for pension funds – have been obscured by short-termism, director remuneration feather-bedding and ultimately sell-off to overseas owners of what we were encouraged to regard as important national assets.

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As if all this was not enough for the Royal Mail share sale to contend with, there are issues specific to this privatisation – the group’s loss-making past, the continuing fall in the volume of letter traffic, concerns over service maintenance in rural areas and the threat (or promise, depending on your view) by First Minister Alex Salmond to re-nationalise the Scottish operations of Royal Mail in the event of a “Yes” vote in the independence referendum next year.

In our sister paper, Scotland on Sunday, my colleague Jeff Salway ably set out the risks for private investors inherent in buying individual shares when diversification and spread of risk is an important requirement for many saving for the long term.

However, all that said, support for this offer has risen rapidly in the past week after a cautious start as tomorrow’s deadline for applications has approached. Over-subscription looks certain and investors may not be allocated all the shares that they asked for.

The share price will be pitched between 260p and 330p, with latest indicators suggesting the exact price will be at or near the top of this range. Some are already predicting the price will reach 340p when dealings start on Friday. Investors are being asked to commit a minimum of £750 and accept whatever price that is determined within that range.

How does that compare? It puts shares in Royal Mail on a price-to-earnings (P/E) ratio of 6.5 to 8.3 times, well below the average 14.5 times earnings of the FTSE All Share index. Deutsche Post, the privatised German postal operator, is at 17.1, while UK Mail Group, a specialist parcel company, trades on 23.53 times earnings.

But arguably the strongest attraction for private investors will be the dividend yield. In this era of near rock-bottom interest rates, the yield looks particularly appealing, coming in at 6.1 per cent to 7.7 per cent, depending on the eventual price struck.

Considering the huge popularity of equity income funds and investment trusts in recent years, the prospective dividend yield will be a big draw for many private investors.

Another benefit is the £2.8 billion of tax credits Royal Mail has accumulated in recent loss-making years, which could mean the company pays no tax in the UK for up to ten years.

Some 10 per cent of the share offer has been allocated to staff, though there is little sign this has softened trade union hostility to the flotation. It is a pity the company did not go further down this route to emulate the transformation wrought by National Freight Consortium in the early 1980s, which was sold to its employees.

However, Gavin Oldham, chief executive at The Share Centre, told the TrustNet website last week that the prospects for Royal Mail look quite good as the strong rise in online shopping should boost its parcel business.

He said: “Doorstep deliveries for goods purchased on the internet, efficient operations and competitive pricing should provide investors with a lower- to medium-risk investment with the potential of good dividends.”

Richard Hunter, head of equities at Hargreaves Lansdown, highlights that the company has undergone a transformation since 2008, aimed at streamlining the parcel business and carrying more packages on the core network. However, he also singles out some negatives. Letter volumes are continuing to decline, while the parcels business is highly competitive. The company has to bear the costs of providing a universal postal service.

Investors need to bear these caveats in mind as they decide whether to subscribe. There are many unresolved issues that will require smart and sensitive management to resolve.

However, the immediate outlook for a small premium on the group’s debut price looks reasonably assured. A minimum dividend yield of 6.1 per cent is not to be passed over lightly. And the longer-term effects of greater competition should bring wider ­benefits.