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This Dirt-Cheap Dividend Hero Is About To Fall Out The FTSE 100. Time To Buy Or Sell?

It was announced early this month that Britain’s oldest and biggest courier Royal Mail will topple from the FTSE 100 following the FTSE Index quarterly review. It joins Just Eat in the latest relegation and will enter the FTSE 250 on Monday, December 24. Not such a merry Christmas, then.

The quarterly reshuffle sees Footsie shares with a market cap smaller than the 110th-largest UK-listed company fall into the second tier, to be replaced by FTSE 250 firms whose market value puts them inside the country’s top 90 firms.

This is the second time Royal Mail has slipped out of the index, the last time being in September 2017, and comes less than a year after it was reinstalled in the FTSE 100. The company falls after a quite-shocking 2018 in which its share price has contracted 38%, with just a few trading days left of the year to recoup some of those losses.

It’s unlikely to enjoy a strong finish to what’s been a terrible year, though, given the bearishness across global stock markets right now. So can we expect more share price weakness at Royal Mail in 2019?

It’s quite possible, certainly in my opinion.

Double Trouble

The letter and parcel giant’s problems have been twofold this year. Most recently the business has been rocked by a damning assessment of its cost-cutting programme by new chief executive Rico Back, a review that prompted an October warning on full-year profits and a subsequent share price collapse.

Back advised that “UK productivity and cost performance has been disappointing”and as a result the cost avoidance target for the 12 months ending March 2019 had to be hacked down, to £100m from £230m previously.

Royal Mail has also been hit this year by a colossal drop in UK letter volumes. The steady decline in this market because of new technologies like SMS and e-mail has been pretty severe, but tough conditions in Britain of late have exacerbated the problem.

Letter flows at Royal Mail dropped 7% between April and October, according to October’s release, those structural challenges worsened by business uncertainty in addition to lower volumes caused by the introduction of the General Data Protection Regulation (GDPR) in Europe.

Whilst the courier has lowered its full-year predictions for UK letter volumes to match the first-half levels, it maintained its medium-term guidance of between 4% and 6% per annum. Given the prospect of a painful and prolonged Brexit process, though, letter volumes could well continue to disappoint.

Low Cost + Big Yields

Despite the prospect of a challenging 2019, though, Royal Mail remains a brilliant stock to pick up today in my opinion. It’s expected to record a 40% earnings fall in the current period but this leaves it dealing on a forward P/E ratio of 10.4 times, a reading that’s just too low to pass up on.

Added to this, at current prices dividend yields at the parcels powerhouse clock in at a colossal 8.8% and 8.9% for fiscal 2019 and 2020 respectively. Trading might be tough right now but Royal Mail still has a strong-enough balance sheet to keep raising dividends, as illustrated by its decision to raise the interim dividend 4% year-on-year to 8p per share.

City analysts are expecting the downtrodden business to steady the ship with a fractional earnings improvement in fiscal 2020. It’s quite possible given the rate at which parcels volumes are growing, and particularly at its GLS pan-European division where revenues leapt 9% between April and September, that it can indeed stage a recovery.

Despite the economic troubles created by Brexit, UK parcel volumes continue to grow strongly and, like revenues, these leapt 6% in the six months to September. Latest retail sales data from the Office of National Statistics showed exactly why, with internet sales in the UK representing 21.5% of all retail transactions for the first time ever last month.

This is the first time the 20% barrier has been breached, and it is an inevitability that the number of online sales will continue to surge. Indeed, head of consumer research David at Parcel Compare predicts that “within a decade half of all our purchases will be online,” and this leaves plenty of scope for profits at Royal Mail to pile higher in the years ahead. I reckon it remains a white-hot buy despite its more-recent troubles.

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