Earnings Transcript for ROYMF - Q3 Fiscal Year 2019

Operator: Ladies and gentlemen welcome to the Royal Mail’s Nine Months Trading Update Conference Call. My name is Mia and I will be the operator for this morning. On this call, today we have Rico Back, Group CEO and Stuart Simpson, CFO. There will be a short overview followed by a Q&A session. [Operator instructions]. Before we start we need to draw your attention to the disclaimer and to follow up statements in the trading update. This sets our example of that factors that can cause actual results to differ from any forward-looking statements we may make. Statistical risk and uncertainties which could affect the Group are summarized in Royal Mail’s half year 2018 to ‘19 financial results and in 2017 to ‘18 annual reports and financial statements which are available on the Royal Mail’s website. I will now hand you over to the company.

Rico Back: Well good morning everybody and thank you for joining this conference call, on our trading and the first nine months of 2018 - 2019. I'm pleased to say that we have had a busy Christmas season. In the UK, we recruited 23000 seasonal workers and opened six temporary parcel sorting centers, to make sure that we have the capacity to handle the high volume of parcels and cards through our joint network. In the December trading period alone we handled a 164 million parcels which is up about 10% last year. I'm also pleased to report that our recent trading performance has continued broadly in line with our expectations and we're now today confirming that we expect to deliver adjusted group operating profit before transformation cost of between 500 to 530 million pounds for 2018 - ‘19. So, overall our group revenue was up about 2% because parcels growth in the UKPIL which is -- and to less off let those revenue decline. In UKPIL, our revenue declined by 1% on an underlying basis which is in line with our first half year. The UK Parcels business performed well over the Christmas period, where parcel volumes and revenues both up 6% on an underlying basis and again in line with the first six months of the first half year. Royal Mail domestic account parcel volumes excluding Amazon were up 8%, partly reflecting our increasing focus on the fast growing clothing and footwear sector of the e-commerce market. Royal Mail tracks 24/48 and track returns very important. Our key e-commerce products continue to grow strongly with volumes up 24%. And our international parcel business cross-border volumes continue to grow. Parceforce worldwide volumes increased by 1%. We continue to expect UK parcel performance will be better in ’18 - ‘19 than it was in ’17 - ’18. Addressed letter volumes excluding election mailing declined by 8% on an underlying basis, largely reflecting the continued impact of GDPR and relatively strong prior year comparative period, which benefitted from the financial sector mailings. Remember, the nine months last year addressed letter volumes were down 5%. Total letter revenue including marketing mail address decreased by 6%, but if you exclude the benefit of elections last year, total letter revenue was down around 5%. But increases in business mail which came into effect this January are expected to have a positive impact on letter revenue going forward. Due to our letter performance to date, we expect to address letter volume decline excluding elections to be in the range of 7% to 8% for '18-'19. While the rate of each substitution remains in line with our expectations, business uncertainty is impacting letter volumes. As a result of that letter volume declines including elections are likely to be outside our forecast medium to term range next year. I'm pleased to confirm that our UK cost of volumes program is on target to deliver £100 million of cost avoided at '18-'19. Cost avoided in the nine months including benefits from line -- which are front of the delayed projects and absorption of the shorter working weeks. Our short term cost actions including the review of our organization structure and management growth are being implemented. The assessment of the productivity and efficiency opportunities under our agreement with the CW review and the UK Network Review are ongoing. Turning to GLS. GLS continue to perform well in terms of revenue and the 9 months including the impact of acquisitions, revenue was up 13% on a constant currency basis. Revenue increased by 8% on an underlying basis, 3 percentage points higher than the volume growth due to a combination of customer mix effect and price increases. Volumes were up 5% on an underlying basis, with our focus on margin protection and continued good growth in international volumes. We will continue to focus on margin protection and as a result, we expect to see slowing and the rate of GLS volume growth next year. Cost pressures on our European and US markets are continuing. However improving price initiatives and cost mitigation actions we are continuing to target an adjusted operating profit margin of over 6% for the full year. The position of both GLS and postal express to an independent contractor model as well as the integration is progressing in line with our revised expectations. In Canada, Dicom is performing in line with our expectations. Other than the updates, we have provided the value of our outlook and other guidance for '18 - '19 are unchanged from what has provided in our half year results. We'll be announcing our full year results on the 22nd of May. And I'm looking forward to speaking to you again, the capital market we plan will be held shortly after that. Well thank you for listening, we’re happy to take questions.

Operator: [Operator instructions] The first question is from the line of David Kerstens with Jefferies.

David Kerstens: Thank you very much. Good morning gentlemen. First question on your longer term letter volume guidance range of 4% to 6% decline. You still think this is a valid range longer term given the fact that you're saying that e-substitution remains in line with expectations. And if you would be looking at maybe a new reality with a relatively steeper decline of let's say 6% to 8% do you still think a progressive dividend policy is feasible that increase a letter volume pressure. And second question on the price mix effect that you reported in the letter business seems to be increasing to around 2% to 3%. Where there any special mix effects in there that explains that’s besides the price increases that you put through early in the year. And can you give an indication of how the 9% price increase in business model is developing from January 1st. Thank you very much.

Rico Back: Well first of all on the letter decline. We have a long term guidance out which is 4% to 6% and that guidance is influenced by various factors which is the GDP development which is the GDPR which is too early to say today now what the effects will be. What we can see is the guidance for this year and since the uncertainty is quite imminent here we believe that for the next year the guidance is as we told. Longer term guidance the longer term numbers and we can talk about this later. So maybe Stuart you talk about cash flow and evidence.

Stuart Simpson: I think David you've picked up on the 4% to 6% is underpinned by the itself which we've said is still the same as has been the driver of the other components of our GDP, and GDPR has come in as a one off. As you know GDP is softer and because of that where the bottom end of the 4% to 6% range. GDPR just nudges over it for a little bit. So we're signaling that for next year. The key driver remains stable. In terms of dividend policy and where we are on that, I think the first thing to note is that this year the cash flow there are two large flip flops year on year, first is a $100 million on the pay deal that we paid for this year related to prior year. The second is this is a 53 week year for us, so there's 13 month payments of payment manager pay in fact when you make those adjustments the dividend is covered for this year. Looking further forward, today as a trading update it's not somewhere where we give longer term guidance on dividend policy et cetera. So I'm not going to comment on that. In terms of price mix effect in letters the 9% business model is really just landed. We remain convinced this will be accretive for the business for this year. So we are comfortable we've done the right thing there. In terms of the price mix effect nothing material to draw your attention to that.

David Kerstens: Okay, great. Thank you very much.

Rico Back: Thanks David.

Operator: And the next question is from the line of Andy Chu with DB.

Andy Chu: Thank you. Three questions please. First of all on GLS. Could you just sort of confirm that you are sort of pointing to sort of volume growth in GLS of below 5% which is your sort of current run-rate as at the nine months for this year. And then in terms of pricing, you sort of point to sort of prudent pricing policy in GLS. And I think your price mix was up around about 3%. So it's feels that that that's tally for this of prudent pricing. Why have you been sort of prudent on pricing? I know you're able to give us flavor of actually what the European pricing environment looks like today? And then in terms of UK addressed letter volumes so next year being pointing to being down more than sort of 6%. Could you just help us in terms of what sort of decline we should be looking at for next year? I mean clearly this was a Q3 exit rate is sort of basically round about 9%. So I mean obviously there is big difference between sort of minus 6 to minus 9% in terms of how the numbers look like. So any sort of help there would be much appreciated. Thank you.

Rico Back: On the GLS, your first question is the 5% volume growth what we have announced. That volume growth is a mix of different countries with different growth states. What we can confirm is that our revenue is up by 8%, which shows you that we did something on prices. But if GLSs in various countries, so the prices in the country differ from an increase in 1% to 2% up to above 10%. So you can't say just one percentage number. What we are doing is in GLS, we are at different margin pressures because of the cost development in the different European countries and we offset that with price increases. That's our activity. And I believe that will grow we'll keep on growing, but the price increases on the country lead, the cost increases in the countries needs price activities which we have done. On the product price mix in the GLS countries, I can say there is just not a big change. It's the general price increases with surcharges and which reflects our activity in the European market. But in general, overall GLS countries, we are targeting profitable growth. And that exactly what we have said in our trading update. Maybe you can talk about the --.

Stuart Simpson: In terms of the UK letters, the figure you quoted for Q3 is slightly inflated, it's less than a very strong prior year where the letters volumes were down 4%. So I think that's an outlier in terms of where we see next year going, we're not going to be drawn on that other than what we said but just to reinforce the ease of as where we seeing it before. And where we talked about in the past is GDP softer that moves at the top of the range effect. And really that's what we're really seeing. So we're seeing 2 at the top of the range because of the softening GDP, then there is a bit of a overlay there on GDPR that kicked in May. So that actually bleeds through a little bit into next year just to move as maybe outside that range. So that's all I'll say on that.

Andy Chu: Okay. Thanks very much.

Rico Back: Thanks Andy.

Operator: And the next question is from the line of Damian Brewer with RBC.

Damian Brewer: Hello. Good morning everybody. I guess a couple of questions for me maybe three. First of all just coming to the parcel business and Rico as you mentioned the overall volume is up 6% but the account volume is up 8%. I normally assume the account volumes carry a different negotiated tariff on them. Could you just say a little bit more about if you stripped out the difference in mix what the underlying pricing on policy was looking like sort of like for like products to account basis. Secondly, and I guess the two tied up together, could you talk a little bit more not so much in constant terms but qualitative terms about how much progress you've made in sort of reinvigorating the momentum to make change in the business particularly given that the first half had those problems of sort of inertia to get the changes in and what's changed there. And then tying into that, given you've stated a 100 million cost avoidance target for the year. If we were to just look at the Q4 rates on that and annualize that what would the Q4 annualized cost avoidance rate look like. Thank you.

Stuart Simpson: If I take those in reverse order, so we're comfortable with 100 million this year Damian, we've not called that we've got so far through Q3 and then still even back into Q4 remember. But we're comfortable on that. I think what I would say is the productivity we expect in the second half has been in first half some of that that we've got very good relations it's very cordial with us, [indiscernible] Rico and I meet the head of the Union on a regular basis. Teams are working together. We continue to work incredibly hard through our trials to see what is going to yield for us in the future. We've managed to get some projects landed so [indiscernible] review it's one of the things first off and up and running short the working week we landed without any wiggle on quality. So those are all good, short term cost sanctions are kicking in, Rico and I have looked at the organization structure in the center through the rest of the operation and management but the [indiscernible] of that so we're comfortable on the 100 million. We expect to deliver on that and we are working closely with the Union to underpin future. I think that gives a bit of flavor on that.

Rico Back: And if I look at the domestic account parcel volumes if I take Amazon out we're up 8%. And that's our increased focus on the fast growing clothing and footwear sector in the e-commerce market. If we look to the switch from un-tracked which is helping our growth at the rolling track 24% 48% and track return volumes, that includes our e-commerce product that's up 24% which underpins our activities in the parcel sector in the UK which is fast growing.

Damien Brewer: Okay, thank you. But could you say a little bit more on what the underlying pricing on say like for like product has done in the parcel business rather it looks like it's flat, but that's a result of the mix but if we were to look beneath the mix on underlying product basis has it also been flat or if there's been increases or decreases there.

Rico Back: If you take all the different products, it's broadly flat, it's broadly flat.

Stuart Simpson: And look Damien the way I think we look at it is incredibly competitive market in the UK, so we've seen in year last I think maybe Europe is not as big however slightly more rationally and there's been little bit of price coming into the market. I wouldn't say we seen that in the UK, it's still incredibly competitive.

Damien Brewer: Okay. Got it. Thank you very much.

Stuart Simpson: Thanks Damien.

Operator: Next question is from the line of Arthur Truslove with Credit Suisse. Please go ahead.

Arthur Truslove: Good morning. Three for me please. First of all, with the parcel growth and obviously there is data the people have been talking about last few days especially in the UK, parcel growth has weakened somewhat. So could you just talk about whether you feel that you're taking share or is it a function of the underlying markets being strong. Second, on the pensions, I think we were all expecting an update on the development of the new scheme and just sort of wondering, where we are in respect of that. And finally, just once again on the volumes going forward. Are you able to provide any color on whether the price increases that you put through are material to the volume guidance being outside of the range of FY'20? Thank you very much.

Rico Back: If I talk first of the parcel growth in the UK, I mean we have and the Christmas period we have about 10%, our underlying growth rate is about 6 the revenue is 6 which indicates for that yes, it's a change in mix but broadly flat pricing. I think the market itself is growing, and we are growing in line with that market, which means that our market share today is sort of stable. Maybe you talk about the pension?

Stuart Simpson: Yeah. In terms of the pension, we still have got strong cross party support, the government consultation players. We submitted our part into that. We're working extremely well with the data we pay in the CWU. You may notice that we've got a lot going on at the minute. So one see any acceleration of the timeline we talked about before, but we're really pleased with the progress that we continue to make in that area. In terms of volumes going forward, our prices have that had any impact on moving the range, it haven't actually negligible in terms of what we're talking about.

Arthur Truslove: And just finally on that pricing. Is the, how much mail volume is actually impacted by the price increase?

Stuart Simpson: The business mail is around 50% of the total mail.

Arthur Truslove: Okay. Thank you.

Stuart Simpson: Thanks a lot.

Operator: Next question is from the line of Joel Spungin with Berenberg. Please go ahead.

Joel Spungin: Hi good morning. I got a couple. First actually is just a follow up from the previous question just to clarify. Are you saying that in terms of your assumptions for future letter volume development? Are you seeing that price increases have a negligible impact on volumes? Is that the right way, the way just said or have I misinterpreted that. And my second question is really just coming back to a point that you don't think there is been any change in e-substitution. I was wondering if you could just elaborate on why that's the case, why do you think that's the case. And how do you know that the weakening volume is a function of GDP as oppose to actually a structural change in demand that will actually the new rate is going to be higher than the previous four to six years to talk about.

Rico Back: In terms of [indiscernible] in price you always have an effect price in volume if you overdo it. I think the way we're doing it is in a way that it does not have that effect. So you can't say, never never but you should do it measured. And that's exactly what Royal Mail is doing, measured price increases is our target. If you look to the E-substitution we are monitoring this on a monthly basis, we can see it in our statistics and the e-substitution is stable. What is instable and difficult to predict is what the GDP is doing and the GDP is changing that will have an effect on the letter volume. And that's difficult to predict in these times.

Joel Spungin: Okay, so just a quick follow-up. How its exactly do you measure e-substitution. I mean is there how do you quantify that in your in your models.

Stuart Simpson: The models we've had established for a long time in combination many different factors going into them from customer surveys, what we can track through coming through from various different customers and how that may have clarified, so it’s a myriad of things it's not one thing that you put your hand on. I think the question I frame as is the model robust? Absolutely because we have the same model running for well over 15 years now and the last time it was change in rates for e-substitution was the last financial crisis and it's been stable since then and it continues to be safe exactly as Rico said.

Joel Spungin: Okay, thank you very much.

Stuart Simpson: Thank you.

Operator: Next question is from the line of Dominic Edridge with UBS. Please go ahead.

Dominic Edridge : However, just two questions from me. Firstly, just with regard to sort of the employee's side of things, employee engagement and the operational KPIs. Could you maybe discuss how you felt things went in calendar Q4 just given obviously the pressure issues on the surface anyway. And also I know it's too early for the quality of service metrics to been published. But could you also sort of give an idea, are you sort of happy with where things are progressing, that clearly there has been a little bit of a under shooting on those in the last couple of quarters. And then the second question just to clarify, it sounds as though on the pricing but should we be thinking that most of the, so the letter side is being done in terms of pricing for sort of the for the foreseeable future with the exception of course of stamp prices. And secondly could you just remind us when you tend to look again that's U.K. parcel prices and when sort of contracts tend to come up for renewal there. Thank you very much.

Stuart Simpson: In terms of employee engagement et cetera, where we had a really good third quarter fiscal fourth quarter calendar year we delivered a great Christmas. So really really pleased with that annual employee engagement survey it actually went up last year despite the prior year and during this year having some really challenging IR environments we're now above large company norm in the U.K. So we're really pleased with that. So that the operational KPIs and the engagement with people we're pleased with over the last three four months. Quality of service it's too early to talk about we haven't announced the Q3. I am pleased with how the operation performed over this and it really challenging period where we get new people on board and we run a different network. So we're pleased with that. But getting us back on track will take more than just three months and then we can.

Rico Back: Maybe on the pricing, I mean this is a trading update and we have announced in our half year results that we are doing price increases and we can confirm that the business in our price increases has been implemented 1st of January. And is that the only price increases our company will have for the future. I probably don't think so. When will the next price increases come? We're going to talk about this to a later stage in time not today.

Dominic Edridge : Thank you very much.

Rico Back: Thanks Dominic.

Operator: Next question is from the line of Jamie Fox with Investec.

Alex Paterson: Good morning everyone, Alex Paterson actually. Can I just ask for your addressed letter volumes for the fourth quarter of this year. Do you expect them to be pretty similar with where they were in Q3 or even improve slightly. I ask just because obviously they've declined in volumes increased in Q3 over Q2 and hit your target. They would certainly need to be flat or possibly even improve a little bit from Q3.

Stuart Simpson: I think now that was a good bit of analysis. Yes I've confirmed that. We tend to be better than where we -- what we saw in Q3.

Alex Paterson: And what would cause that improvement.

Stuart Simpson: I think if you recall one of the other earlier answers I got was we're lapping a very strong quarter last year which is part of the reason the Q3 was as high as it was, it was 4% in Q3 last year.

Alex Paterson: Great. Thank you.

Stuart Simpson: Thanks Alex.

Operator: The next question is from the line of Sumit Mehrotra with Societe General.

Sumit Mehrotra: Hi, just one question on GLS. What progress do you see now versus H1 in terms of pressures both in Germany as well as in US in terms of labor costs. Do you think there's any letup or is conditions still remain quite trim.

Rico Back: The two countries are a synonym for many other countries. The pressure on labor is as it was in the first six months. So we can see contingent trend on labor pressure which is basically cost pressure which is the reasons why we took the deliberate decision to mitigate these constant pressures through pricing activities in Germany and in the US it's the same. I mean but it's not only there, you can see all over Europe, as you can see it in the US as well.

Sumit Mehrotra: Thank you.

Operator: [Operator instructions] And the next question is from Sam Bland with JP Morgan.

Q – Sam Bland: Hi, two questions please first on letters. First one was you said that you don't think the 9% price increase will have much of an impact on volume. So the obvious question is kind of how do you know is it too early to tell. Given that that's only been in place for a little bit less than a month. I appreciate you might get some forward volume forecasts from your customers historically those turned out to be accurate particularly when you put through higher price increases than in the past. And the second question is where you expect letter volume to be outside of the 4% to 6% range in future years. I guess it's roughly three things going on there that one's GDPR, one price increases as you said it's probably not much to do with that. And the other is business confidence. I think you're saying that probably the primary reason the letter volume will be outside of the 4 to 6% range is business confidence, could you just confirm that. Thanks.

Rico Back: Well I like I said the biggest factor which we see so far is the business uncertainty the business uncertainty is being reflected in the GDP growth. And we have so far no assumptions on the GDP growth which is different to the future which is quite difficult to predict right now. So that will be the biggest effect. I think the e-substitution is sort of the same. And we don't see lots of other changes in how we measure. But the uncertainty which we have right now in the U.K. economy is that -- that's the basic reason which is difficult to predict long term.

Stuart Simpson: In terms of the prices. We have some a long history and very detailed models around the price elasticity of all the different sent through the mail. We apply our price increases very judiciously in the right place based on all our analysis historic analysis looking at how the markets behave. We're comfortable that we made the right call. Clearly there'll be a movement around the edges but this will be an accretive move for us this year.

Sam Bland: Could you just remind. I think when was the last time you put your price increase of this magnitude.

Stuart Simpson: Gosh! it was probably about 12-13, so it's about five six years ago.

Sam Bland: Thank you.

Stuart Simpson: Thank you.

Operator: [Operator instructions] And we have a follow-up question from Arthur Truslove with Credit Suisse.

Arthur Truslove: Just following up once more on the letter pricing. Typically do letter pricing tends to be sort of 2% or 3%. Is that a reasonable expectation for the next 12 months as well or does this 9% obviously offset by some factors dictate that letter pricing should be sort of outside that sort of range. Thank you.

Rico Back: I'm sorry to say but we’re here in a trading update and we have done the 9% for this year and we're not giving a forward looking statement up on price developments over long term future. Sorry.

Stuart Simpson: Are there any more questions?

Operator: So far we have no further questions.

Stuart Simpson: Okay. No further questions and we'll bring the call to the end. Thank you very much everyone for taking the time to dial-in and join us. Thank you very much for the questions. As you know Catherine will be around to take any follow-up. Thanks everyone, bye bye.

Rico Back: Thanks everyone.