I approached these two stocks in a cynical frame of mind, expecting to damn rather than praise them. Yet on closer inspection, both have their attractions and now I think they might be worth popping into a balanced Stocks and Shares ISA portfolio.
Royal Mail (LON:) Group
Investors in Royal Mail Group (LSE: RMG) have had a rotten time lately, with the stock plunging 55% in the past 12 months. Deservedly so, given that it has issued a string of bad news for investors, as it battles to cope with falling letter volumes and advertising revenues, plus the added threat of renationalisation by any Jeremy Corbyn-led Labour government.
Investors felt even more pain when management hacked back the dividend by a hefty 40% earlier this year. The cut doesn’t look so drastic in retrospect, given that Royal Mail was yielding an unrealistic 12% at the time. Today’s forward yield is still a bumper 7.7%, covered 1.5 times by earnings, although you can’t completely rule out another cut.
Today’s valuation is drawing in bargain seekers, and Royal Mail certainly looks tempting trading at 8.7 times forecast earnings. The downside is that analysts are predicting a 24% drop in earnings per share this year, followed by a small 4% rebound in the year to 31 March 2021, as revenues climb slightly.
Royal Mail is a lumbering beast in a competitive industry, with operating margins of just 1.5%, albeit forecast to rise to 2.9%. A return on capital employed of 5.9% also underwhelms, while management needs to invest heavily to drive future growth.
That said, if you like buying troubled companies, you might be tempted by its recovery prospects. I’d call it a risky buy for long-term income and growth seekers.
Doesn’t time fly? In September, it will be exactly five years since David Lewis was appointed Tesco (LSE: TSCO) boss with the brief of turning the company around after a string of setbacks, including failed foreign ventures, an accounting scandal and disenchanted customers.
Lewis has done a solid job but now I’m wondering whether the early magic is wearing off. Maybe like football managers, CEOs can only outperform for a limited period, before the whole operation needs a reboot.
Tesco’s market share fell another 20 basis points to 27% in Kantar’s most recent set of figures, yet I actually think the group has done well to hold onto so many customers, given the many challenges it faces. The grocery sector is one of the toughest of all, as customers feel the pinch, as Aldi and Lidl power on, and as Brexit weighs on just about everything.
City analysts are surprisingly optimistic about Tesco’s future, predicting double-digit earnings growth for the next three years (13%, 10% and 11%). I haven’t seen such a positive set of earnings predictions for a stock in some time. You can buy the Tesco share price at 12.8 times forecast earnings too, adding to the attraction. Others take a less rosy view of this stock, though.
The forecast yield of 3.8% is below the FTSE 100 average but nicely covered twice by earnings, and it’s forecast to hit 4.4% in the next couple of years. Maybe Lewis can work his magic a little longer.
Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019