A few weeks ago, I said that Royal Mail shares looked tempting, given the big dividend yield they offered. However, I am surprised at just how much they have gone up in the first few days of trading.
Various City brokers have claimed the shares were undervalued at the flotation price of 330p. They have pointed to things such as the possibility of a big potential windfall from selling surplus London properties. On the basis of a few days trading, it looks as if they were right, but are the shares still worth buying now?
With a starting annual dividend of £200m, the shares offered a yield of 6.1% at 330p. Now at 480p that yield is down to 4.2%. That’s OK, but I can buy other, arguably safer, blue-chip shares, such as National Grid (LSE: NG) or GlaxoSmithKline (LSE: GSK), with higher yields than this.
It all comes down to how fast Royal Mail’s dividends can grow in the future. You could argue that payouts have the potential to grow substantially. The main reasons for this are twofold: profits can keep going up as the business cuts costs.
Cash flows will surge as the heavy investment in making the business more efficient in recent years comes to an end. Throw in the fact that the firm won’t pay much tax for a long time and you can paint a bullish picture for the shares.
Alternatively, strong cash inflows can be used to pay off the company’s £1bn debts. This will increase the value of the shareholder’s equity – just like paying off a mortgage – and could be another reason for the share price going higher. But the risks have not gone away.
The letters business is declining and the unionised workforce could still cause trouble – even though their shares are worth a lot more than they were a few days ago.
The problem for most private investors is that they were only able to get their hands on £750 worth of shares at the flotation. That’s probably not enough to make a big difference to them or produce a decent income stream. That said, the shares could still do well in the long run, but I’d wait for some of the early froth to be blown off before buying any more.
Verdict: wait for the shares to fall back