Royal Mail addresses costs as first-half profits fall 25%

Royal Mail nudged up its half-year dividend despite a 25% decline in operating profits for the first half of the year.

Six weeks after warning it was having difficulty cutting costs and a week after UK post and parcels chief Sue Whalley was ousted, the FTSE 100 company set out more details about its "performance issues" and what it was doing to address them.

Chief executive Rico Back, who was promoted to the top job four months ago, said not much progress was expected in terms of productivity improvements in the first quarter of the year as it came fresh on the back of signing off a new pensions and pay agreement with the Communication Workers Union in March.

But hopes of better productivity during the second quarter were slower to come than expected, he said, due to a combination of factors, including the "continued after effects of the industrial dispute, delayed implementation of cost avoidance projects and the complexity involved in implementing elements of the agreement", which led to the cutting of cost avoidance targets from £230m to £100m.

He said a "range of actions" across "all areas of the business" have been put in place to improve performance and confirmed guidance of adjusted group operating profit before transformation costs of £500-550m for the full year.

For the 26 weeks to 23 September, Royal Mail generated revenue of £4.9bn, up 1% on the previous year, while adjusted operating profit before transformation costs were down 25% to £242m as adjusted operating profit margins shrank 150 basis points to 3.9%.

The UK parcels and letters business, known as UKPIL, produced revenues of £3.6bn, down 1%, with parcel revenue and volumes up 6% and letters volumes down 7%, or 5% if the impact of previous elections is ignored. Operating profit fell 29% to £165m.

Given the performance to date, UK parcel volumes and revenue growth rates for the full year are expected to be better than in the previous financial year.

GLS, the overseas parcels business, lifted underlying revenues 9% to £1.4bn thanks to good volume growth and price increases, while adjusted operating profit margin declined to 5.7% because of the labour and other cost pressures associated with that economic growth, and due to losses in France and the US. Profit fell 14% to £77m. For the full year, Back expects to recover some of the lost margin in the second half to bring adjusted operating profit margins back over 6%.

At the group level, adjusted profits before tax fell 27% to £183m in the half year and basic earnings per share declined 32% to 13.6p. Net debt was up to £470m from £382m a year ago.

In line with the progressive dividend policy and arrangement to pay out a third of the prior year's total dividend as the subsequent interim payout, the half-year dividend was lifted 4% to 8.0p. Several analysts have warned that the dividend is at risk.

Current trading is in line with revised expectations, Back said, with the overall outlook and other guidance unchanged.

RMG shares rose almost 2% to 354.1p in the first hour of trading on Thursday.

After the profit warning six weeks ago, the sharp falls in profit across the board were unsurprising, said broker Liberum, noting that UKPIL margins were squeezed by weaker revenue and poor productivity.

At GLS the recent US acquisitions "appear problematic", which is a new negative, resulting in a goodwill impairment charge.

Liberum analysts, which have a 'sell' on the shares, said: "FY guidance has not changed since the warning and we see consensus as unlikely to move materially from the bottom end of the guidance range. Dividend growth continued as per policy, but we see this as unsustainable. Royal Mail faces significant structural challenges with little visibility on how the business might be turned around."

Market analyst Richard Hunter at Interactive Investor said there were few "chinks of light" in the statement.

He added: "It had been hoped that this set of figures would be accompanied by a strategy update, but this is not likely to arrive in detail until a capital markets day in March. Meanwhile, this leaves investors to pore over any number of weaknesses – margins under pressure, earnings per share suffering a precipitous drop, pre-tax profit down 57% and net debt up 23%. The productivity and cost avoidance issues which were responsible for the share price collapse in October remain at the top of the to-do list, whilst the important Christmas period now takes on additional significance for Royal Mail given the challenging backdrop."