FTSE slumps by nearly 3% but Royal Mail bucks falling trend

As markets slumped once more on yet more bad economic news, an exception for once was Royal Mail.

After recent weakness due to competition concerns, the privatised operator added 7.5p to 407.4p in the wake of Tuesday’s sale of its Paddington site to property group Great Western Developments for £111m in cash with another £20m due if planning permission is granted. The price was higher than analysts’ estimates, and reinforced the view that Royal Mail had undervalued assets on its books. In a buy note Matthew O’Keeffe at Berenberg said:

At the full amount, this is 85% above our own valuation for Paddington at £71m. Pre-planning permission, it is 56% ahead of our valuation.

A key element of our buy case for Royal Mail is predicated on the company selling three major sites in London that it has “recognised as surplus”. These sites are in Paddington, Nine Elms and Mount Pleasant.

These sites have been the subject of speculation among property investors, with estimates ranging from £250m to £500m for the three sites compared to our estimate of £1bn. The Paddington sale demonstrates the potential undervaluation of these sites and supports our buy case. The bulk of the value comes from Nine Elms, which is a 14-acre site that we value at £662m. Mount Pleasant is also significant at over eight acres; our estimated value is £267m for the site.

While we understand that Paddington will carry a premium to either of the other locations, they are nonetheless in central London and we would expect that Royal Mail will be able to sell these sites for at least our estimate. If we were to assume a 30% premium for each of the other two sites, it would add another £387m to our already-above-consensus estimates.

We continue to view Royal Mail as the best play in the logistics space despite recent and ongoing margin concerns. We believe that these margin concerns will ultimately prove to be overdone and that Royal Mail, like its peers previously, will enjoy a sustained period of cost reductions having shifted from being a government-owned business to one that is listed. This potential for operational outperformance, together with the prospect of better than expected sale proceeds, drives our £7 price target and buy recommendation.

But Credit Suisse was less optimistic:

Whilst the sale of the Paddington asset was unexpected with only a year having passed since the IPO, two sites remain within the portfolio of significantly higher complexity to dispose of. We remain underperform on Royal Mail driven by concerns over UK parcel trends, growing competition in domestic mail and sustained margin pressure at [Amsterdam based] General Logistics Systems. We expect consensus to continue to drift and see risk to 2015 Royal Mail guidance.

Overall though another bout of poor data – US retail sales, producer prices and weak Chinese inflation figures – confirmed recent concerns about a global economic slowdown, sending the FTSE 100 181.04 points lower to 6211.64, its biggest daily fall and worst level since June 2013.

Added to that were growing worries about further political turmoil in Greece, anxiety ahead of the results of the latest European bank stress tests, as well as uncertainty over the situation in the Middle East and the spread of the Ebola virus.

Heathcare shares came under pressure on suggestions that US group AbbVie may abandon its bid for Shire, down £11.28 at £40.12, with the US government threatening to clamp down on the tax benefits of relocating to Europe.

Other possible US targets were also weaker, with AstraZeneca 141p lower at 4264.5p and Smith and Nephew dropping 52.5p to 921.5p.

With the worries about global demand, added to talk of oversupply, Brent crude continued to slide, down to a new low of $83.37 before recovering slightly.

FTSE slumps by nearly 3% but Royal Mail bucks falling trend