UPDATE 2-UK's Royal Mail rattles investors with warning of rising competition

Thu May 22, 2014 5:47am EDT

Related Topics

* FY operating profit up 12 pct to 671 mln stg

* Parcel rev up 7 pct, letters down 2 pct

* Sees rising parcel competition

* Calls on Ofcom to review rival mail delivery service

* Shares down 6.7 pct (Writes through, adds comments, details, shares)

By Neil Maidment

LONDON, May 22 (Reuters) - Newly privatised Royal Mail pointed to tougher times ahead on Thursday as it said competition in parcels was intensifying and warned the emergence of a rival British mail delivery service threatened its growth prospects.

The blunt reference to the headwinds it is facing took the shine off a 12 percent rise in full-year profit for the company, which remains embroiled in a political storm over its privatisation, sending its shares down 6.7 percent as the day's biggest faller in the blue chip FTSE 100 index.

Royal Mail's growth prospects continue to split analyst opinion, with differing views over its ability to manage declining letter volumes and increasing competition, at the same time as growing its parcels business and cutting costs.

Chief Executive Moya Greene said full-year results had met the company's expectations and added it would stick to its target of single-digit revenue growth, margin expansion and underlying free cash flow growth for 2014-15, despite the gloomier outlook which she said there were plans to manage.

"The parcels side is certainly a more intensely competitive environment than it was last year," Greene told Reuters. "On the letters side, the headwind is direct delivery," she added, referring to the prospect of its first mail delivery rival in its 500 year history in the form of TNT Post UK, part of Dutch-based PostNL.

"Without timely regulatory action, direct delivery could undermine the economics of the universal service and our ability to generate sustainably a 5 to 10 percent operating profit margin in our reported business," Greene said.

Competition in parcels, worth 51 percent of Royal Mail's turnover, is ramping up as firms compete on price and extend hours to service a market booming on demand for online shopping.

In the past year Amazon.com Inc, Royal Mail's single biggest parcels customer, worth 6 percent of sales, launched its own delivery service.

To better compete, Royal Mail has matched rivals by launching a trial Sunday parcels delivery service and is targeting a greater portion of the clothing returns market.

CALL FOR ACTION

In letters, where volumes are falling at a rate of between 4 and 6 percent annually as customers switch to email, TNT Post UK's plans for a UK mail delivery service by 2017 is a big headache for Royal Mail, due to its tactic of targeting only the most profitable areas of the country and leaving Royal Mail to deliver the remaining less profitable, or loss-making, areas.

Royal Mail says it will be much harder to deliver its six-day-a-week, anywhere service and at the same time grow operating profit margins to a targeted range of 5 to 10 percent. It wants regulator Ofcom to review the industry ahead of its commitment to do so by the end of 2015.

Without regulatory action, Royal Mail estimates direct delivery could impact its revenue by over 200 million pounds by 2017/18. Greene said the group was talking to legislators to help garner support for an earlier review and it would submit a report pushing for this to Ofcom in coming weeks.

An earlier move to mitigate the impact of TNT Post's rollout, through proposed wholesale price hikes, was suspended by Ofcom in April and now faces a review.

Analysts at brokerage Panmure Gordon said competition concerns would drag on Royal Mail's shares in the near term but maintained its "hold" rating on the stock.

"Longer term prospects remain attractive, as we expect an element of regulatory intervention to protect Royal Mail's need to achieve a commercial return on its activities," they said.

Ofcom, however, said in a statement the financial sustainability of the universal service was not under threat. "We would expect Royal Mail to take appropriate steps to respond to the challenge posed by competition, including improving efficiency," a spokesman said.

Royal Mail, which had long posted financial losses until two years ago, said on Thursday operating profit before "transformation" costs - such as mail centre modernisation and staff cuts - rose to 671 million pounds ($1.1 billion) in the year to March 30, in line with a consensus forecast.

Group revenue rose 2 percent to 9.46 billion pounds, helped by a 7 percent rise in parcel sales, where higher prices made up for flat volumes. UK letter revenue fell 2 percent on volume down 4 percent, at the lower end of a guided range between 4 and 6 percent.

The privatisation of Royal Mail was heavily criticised for short-changing the British taxpayer, with government ministers, banks and advisors hauled before lawmakers to explain why shares in the firm rocketed as much as 87 percent above the 330 pence price at which Britain sold a 60 percent stake in October.

($1 = 0.5925 British Pounds) (Editing by Kate Holton and David Holmes)

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