The Royal Mail 's Capital Structure

A Critical Review of the Royal Mail’s Capital Structure
Introduction
This report will critically review the capital structure of the Royal Mail (RM) and the implications this has for the company with reference to its apparent value and the return required by equity investors. The report will take data from the latest set of accounts published by the RM and it accompanying investor reports. It will also refer to investors analysis and news item in an attempt to gain a qualitative impression of RM’s share value.. The numerical analysis will not use information that relates to time past the last full accounting period, however the conclusion will attempt reconcile any share price movement with the analysis. The report will assess three models for their suitability in analysing the capital structure of the RM, (Weighted Average Cost of Capital (WACC), Capital Asset Pricing Model (CAPM) and the dividend valuation model).

The Royal Mail is a FTSE 100 company founded nearly 500 years ago by Henry VIII under the name “The King’s Post” (http://www.royalmailgroup.com/ 2015). The UK Government on 15th of October 2013 began the process of transferring ownership of the RM from public hands to private investors. The first sale the government sold shares to the value of £1.98 to a mixture of staff and institutional investors. The shares were split such that the government retained a 30% stake, RM staff received 10% (free) and 60% was sold to institutional investors. The Government sold it remaining shares on 11th of June (15% to investors and 1% given to staff) and 12th of October (13% to investors, 1% given to staff) (House of Commons 2015).

Assessing the capital structure of any firm is important for investors attempting to determine if...

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...ated a higher share price.

The WACC model however looks at cash generated and the RM’s profits before tax was £569m (an operating profit of £595m), higher than the required return. Post tax profits where £431m. If we assume investors would desire a higher return than the WACC suggests due the unquantifiable risk, it seems reasonable for a rational investor to consider RM’s shares to be overvalued although not as much as an investor using the dividend model.
As higher investors generally expect higher returns for a more leveraged firm (Arnold 2013 p 697) there would appear to be very little scope for the RM to increase its debt capital unless it can convince investors profits are likely to profit significantly. Unfortunately the annual report does not suggest such growth is likely short term, due to increased parcel competition and falling letter sales (RM 2015).