Stamp booty

Royal Mail should price below middle of IPO range

Royal Mail shares should be priced below the middle of their £2.6 billion to 3.3 billion range. The growth story for the UK postal service is uncertain at best. That means the stock would need strong support from a high dividend yield when the company is privatised.

True, there is some potential. About half of Royal Mail's business is delivering parcels. British consumers do just under 10 per cent of their shopping online at present. That's already more than in Germany or America, but it is reasonable to assume that online retail will create more business for logistics outfits, Royal Mail included.

There's some upside in letters too. Volumes are declining at about five per cent a year, the Royal Mail concedes, but margins could expand with more aggressive cost cutting. Operating margins, currently 4.5 percent, could plausibly rise to five per cent this year. Royal Mail might push them to the high single digit figures enjoyed by some European peers.

The snag is that rising demand for parcel logistics is also attracting more competition. And, while efficiency gains might soften the blow in letters, Royal Mail's heavily unionised workforce means it has to be careful about cuts. For every step forward, Royal Mail seems destined to take at least part of a step backwards.

Gains in parcels and letters might enable Royal Mail to lift annual dividend payments from the £200 million already promised in the short term. But the longer-term outlook for a market facing structural change and increased competition is harder to gauge. Dividend income - even at elevated levels - translates into reliable investment only if the payments can be sustained.

Meanwhile, Royal Mail faces competition as an income stocks too. UK bank stocks are in recovery mode and some will resume paying proper dividends in the next couple of years. At the top of Royal Mail's price range, the shares' dividend yield would be a healthy six per cent. At 285 pence to 290 pence, just below the middle of the range, the yield would be a more generous seven per cent. That is the minimum investors should accept to compensate for the modest growth story.