Citi ups Royal Mail to 'buy' on Covid-19 parcels surge

Citi upgraded Royal Mail to 'buy' from 'sell' after parcel volumes increased during the Covid-19 lockdown and the company's shares fell further than its peers.

Along with its "double upgrade", Citi increased its target price on Royal Mail shares to £2.10 from £1.50.

Royal Mail is the leading parcels operator in the UK with more than 50% share of the delivery market. It has the majority of the business-to-consumer market in the UK and abroad through its GLS parcels division, Citi analysts said. This makes the parcel division Royal Mail's "crown jewel".

The company is "acutely exposed" to the increase in e-commerce that has taken place during the Covid-19 crisis, Citi said. British Retail Consortium figures show online non-food sales up almost 19% in the five weeks to April.

For every 1% rise in annual volumes Royal Mail earnings increase by 20%, Citi said. The bank expects parcel volumes to rise 9% in Royal Mail's fourth quarter, which ended on 31 March, and for volumes to increase 13% in 2021. Both estimates are ahead of consensus. Those forecasts mean Citi's estimate for 2021 operating profit is 400% more than consensus, it said.

Royal Mail shares are down 38% in 2020 compared with peers' decline of about 27%. There are good reasons for this because of pressures on Royal Mail's letters business and advertising mail during the lockdown, Citi said. But Royal Mail's £1.5bn market value and £300m of net debt suggest GLS is valued at almost nothing in the share price with the UK operations valued at £1.40 a share.

"We double upgrade Royal Mail to buy and revise our target price to £2.10. Our upgrade is predicated upon two points: 1. A significant and recent acceleration in parcel volumes; and 2. An attractive and nuanced valuation," Citi said.