Questor share tip: Royal Mail is not undervalued, Karl Marx says so - Telegraph.co.uk

Given the excessive demand for our national postal service it is all but certain the shares will be priced at 330p per share this week. The very top of the range provided by bankers of between 300p and 330p, valuing the group at £3.3bn.

Analysts at Panmure Gordon said the company was worth up to £4.5bn, or 450p a share — well in excess of the current upper valuation.

If Panmure are right, this will create paper gains for investors of £1.2bn, or 120p a share.

There has been plenty of emotive tubthumping from Labour politicians.

"This is ripping off the taxpayer on an epic scale," said Alan Johnson, a former business secretary, while Chuka Umunna, the shadow business secretary, said the float should be halted on the grounds that the taxpayer could get a better deal by waiting.

He added: "What they need to illustrate is they are going to get the best value for the taxpayer and increasingly what this is looking like is a massive bonanza for City speculators and a huge short-changing of the taxpayer at the same time."

The facts simply don't bear this out. Royal Mail's closest peer in terms of company structure and market dynamics is the Belgian Postal Service bpost. Both companies have monopolies on their core market, both are suffering from domestic letter volumes declining by between 4pc to 6pc a year, offset by double digit growth inparcel delivery, driven by internet shopping.

A common way of valuing shares in a company is to use a multiple of its earnings, or EBIT. Belgian operator bpost made €404m (£342m) in earnings before interest and tax (EBIT), in the year ended December 2012. Bpost is valued by the stock market at €2.9bn, or 7.2 times the EBIT. Royal Mail made £376m of EBIT, in the year ended March 2013, using the same earnings multiple as bpost you would reach a value for Royal Mail at £2.7bn. On this basis the UK postal group is selling at a premium.

Royal Mail is expected to improve its profitability, or EBIT, over the next few years after cost savings under the leadership of chief executive Moya Greene, and that is why people are willing to pay more. But overall that premium looks about right, not expensive and by no means cheap.

Another way to look at value is the dividend yield. The dividend yield on a share is derived from the share price and the dividend income. Royal Mail said it would have paid out £200m to shareholders during a full-year's trading, that works out at 20p per share, or a yield of 6.1pc given a 330p price. Bpost pays a dividend to investors that offers a yield of 6.9pc. The higher the share price the lower the yield, and by this measure Royal Mail is at a slight premium to its peer.

Deustche Post DHL, the German postal and parcel service is another sector peer. Deutsche Post shares trade at €23.77, offer a dividend yield of 3.6pc and trade on 10.5 times EBIT. On this example you could say that Royal Mail is undervalued on every measure. However, Deutsche Post has one major difference: a fast growing international parcel business DHL that is the market leader in Asia. Deutsche Post warrants its higher rating because of this higher growth DHL unit, Royal Mail does not have any exposure to this higher growth markets in Asia.

Investors are getting net assets of £1.38bn, or 138p per share, a dividend yielding 6.1pc and that looks very reasonable compared to peers already in the market. It doesn't represent taxpayers being shortchanged, as UK taxpayers can buy shares and enjoy any potential gains. If anything, by offering a low price, the government is offering more gains to investors who include taxpayers.

Ultimately it is not the company that is undervalued by the government's price either, as Karl Marx pointed out, it is the labour, no more so than the hard working staff at Royal Mail. They should be forgiven a wry smile when the shares float next week when something they knew all along becomes all too apparent, namely that they have been undervalued for years. Investors who agree that Royal Mail is an essential service and has a secure market position should sign up for shares. Buy.

Royal Mail IPO

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