The Royal Mail (LSE: RMG) share price has jumped around 14% since the beginning of November. But I think the stock remains undervalued, despite this performance.
Indeed, shares in the delivery company remain below their 52-week high of 606p. Over the past 12 months, the stock has returned 46%, excluding dividends.
Growth returns
To understand why Royal Mail has performed so well over the past year and continues to look undervalued, in my opinion, I need to highlight how the City’s growth expectations for the business have developed over the 12-month period.
This time last year, analysts had pencilled in earnings per share of 9p for the firm in its 2022 financial year. Analysts were also forecasting earnings of 18p for fiscal 2023.
However, a year later and analysts are forecasting earnings per share of approximately 61p for this financial year and fiscal 2023.
The reasons behind the upgrades are twofold. First of all the company’s revenue performance has been better than expected. Parcel delivery volumes have continued to exceed expectations as consumer trends developed during the pandemic have persisted.
The company has also reduced costs and improved efficiency faster than expected.
These twin tailwinds have catapulted profits higher, and shareholders are reaping the rewards. As well as the capital gains registered by the stock, management has also outlined plans to return £400m to shareholders with dividends and a share buyback.
Using these figures, the stock currently yields 4.7%. And based on City growth estimates, the Royal Mail share price is currently selling at a forward price-to-earnings (P/E) multiple of 7.3. Its five-year average P/E is closer to 10.
The outlook for the Royal Mail share price
Considering the current trends in the parcel delivery market and Royal Mail’s progress in cutting costs and improving efficiency, I think the company has enormous potential.
This potential, as well as the firm’s current valuation, are the reasons why I think the stock is undervalued.
That said, the company does face several risks and challenges. These include rising labour costs and the supply chain crisis. Both of these issues could significantly impact the group’s overall cost base, reducing overall profitability and growth. I will be watching to see how these affect the corporation as we advance.
I will also be keeping an eye out for Royal Mail’s progress against competitors. The delivery market is only becoming more competitive, so the firm needs to keep ahead of its rivals or it could be left behind.
Still, even after taking these risks into account, I think the company has a lot of scope to grow over the few years. Management’s plans to reward shareholders with extra cash also suggest that further cash returns could be on the cards as profits rise. Based on these factors, I would buy the shares for my portfolio today.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
