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Edited Transcript of RMG.L earnings conference call or presentation 21-Nov-19 9:30am GMT

Half Year 2020 Royal Mail PLC Earnings Presentation

London Dec 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Royal Mail PLC earnings conference call or presentation Thursday, November 21, 2019 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* James Rietkerk;General Logistics Systems B.V.;CEO

* Rico Back

Royal Mail plc - Group CEO & Director

* Stephen Agar

Royal Mail plc - MD of Consumer & Network Access

* Stuart Simpson

Royal Mail plc - Chief Finance & Operating Officer and Director

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Conference Call Participants

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* Alexander Paterson

Peel Hunt LLP, Research Division - Analyst

* Alexander Irving;Sanford C. Bernstein;Senior Research Associate

* Arthur David Truslove

Crédit Suisse AG, Research Division - Research Analyst

* Chi Onn Chu

Deutsche Bank AG, Research Division - Research Analyst

* Damian Brewer

RBC Capital Markets, Research Division - Analyst

* David Kerstens

Jefferies LLC, Research Division - Equity Analyst

* Mark John McVicar

Barclays Bank PLC, Research Division - Head of European Transportation Research

* Samuel James Bland

JP Morgan Chase & Co, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to Royal Mail's Results Presentation. Please ensure you have all mobile devices switched off or on silent. There are no fire alarm tests planned for today. In the event of an alarm sounding, would you please leave the auditorium by the fire exits at the front of the room.

Before we start, we need to draw your attention to the disclaimer on forward-looking statements. This sets out examples of the factors that can cause actual results to differ from any forward-looking

statements we may make. A summary of the principal risks and uncertainties, which could affect the group were set out in its interim financial report for the half year ended 29th of September 2013 (sic) [2019] and will be updated in the annual report.

All of these risks and uncertainties have the potential to impact the group's business, results of operations, financial condition and prospects adversely.

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Rico Back, Royal Mail plc - Group CEO & Director [2]

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So good morning, and welcome to our half year results presentation. A special welcome to our Chairman, he's here today. And our non-executive

Simon Thompson, very nice that you've made it [work.] Happy welcome to you all here [in these days.]

We told you in May 2019, about our 5-year vision. We said, we're going to grow the business, targeting about GBP 12 billion revenue by 2024. We're going to become more efficient, targeting an operating profit margin of over 5%. And to diversify the business with over 70% of revenue from parcels and over 40% generated outside of the U.K. Today, we will update you on the progress we have made as well as sharing our half year performance and outlook.

I'm really pleased that we have had a good start to the year, despite a number of headwinds, business uncertainty, GDP, industrial relation issues that were the headwinds we had [for] both GLS and U.K. have performed well.

Group's revenue was up 5.1%. In the U.K., domestic account parcels volumes, excluding Amazon, grew [up] about 7%. Parcels now account for 63% of group's revenue and 38% of revenue comes from outside of the U.K. Revenue also benefited from the latter price increase, which we had in January and the European elections in May.

We are making progress on our U.K. transformation not as fast as we wanted due to the industrial relation unrest, but we are making progress. Our productivity improved by 2.2%. This compares with an 0.2% reduction in the first half of last year and 1.9% improvement in the second half of last year.

We are on our track with our cost avoidance program of GBP 150 million to GBP 200 million for this full year. We have already secured cost of volumes of GBP 86 million. So we've had a good start in the year trading cash flow, and we are pleased to announce an interim dividend of 7.5p in line with our new dividend policy.

Looking ahead to the second half of the year whilst we will benefit from the upcoming general election, from Christmas trading and from continued growth in parcels. We are also facing some headwinds. As a result of business uncertainty and lower [than] GDP growth, we expect adverse latter volumes, excluding the election, declined by 8% in the first half of the year.

We are now guiding to decline of 7% to 9% for the full year and 6.8% for next year. And of course, we face an uncertain industrial relation environment. We told you in May that we need to change. Our people recognize the need for change, but change is always difficult. We are pleased to have been able to take action to secure mail service during the general election and protect Christmas deliveries for the U.K. public and for our customers. But the industrial relation situation remains uncertain, and we cannot promise that there won't be industrial action in the future.

We have honored our agreements with our unions, and we would like to work with our unions and our people to deliver the change needed. We hope, the pause in industrial action will allow us to have a meaningful discussion with our union and our people to work together to build a strong and successful Royal Mail in a changing market. I just talked this morning to Terry. I invited him to talk, wrote a letter to him. We've got an answer. I think, Sally, we're going to talk Thursday, next week. So it's a good sign that the invitation is starting our negotiation discussion with the unions.

We will maintain our profile guidance for the full year. But because of the industrial relations environment and the elections, we are investing more to protect service. And whilst we've had a lower transformation cost, including voluntary redundancy in the first half of this year, we expect this to step-up in the second half of the year. But again, just to make it clear, our profit guidance for the full year remains unchanged.

Very important for us to be credible about our forecast.

Let me tell you more about how we're doing with our strategic objectives. The first one growing. Revenue in the U.K. was up 1.8%. This is the highest growth rate for 5 years, and that was achieved, despite letter volume pressures. In fact, our half year letter revenue performance was also the best in 5 years as a result of price increases introduced early this year and the European election. Our parcel revenue is strong, and we have introduced a number of innovations that are helping us to win more customers and a bigger share of wallet. We were first to the market in the U.K. is now [appended] relative feature and our app to size the parcel and calculate the right postage is great. And now you can track parcels on Alexa, using a phrase like mum's parcels instead of reading a long parcel number each time. I think it's quite good for a 500 year old company. Our aim is to make e-retail experience easy for our customers. If you want to send or return a parcel, you can do it all online. If you don't have a printer, you can pay for your postage on your phone and take your parcel to one of our 13,000 Royal Mail customer service points or post offices where there we'll scan your phone, print out your label. If you print your label at home, you can now drop off 24/7 at our 1,400 new parcel post boxes. I think that's quite easy and convenient.

We saw very good performance from GLS, our growth engine. Revenue was up 14.1% in total and 8.9%, if you exclude acquisition. GLS U.S. has improved year-on-year, and is performing well.

And I'm happy to say that Mountain Valley Express has joined the GLS family. Mountain Valley Express, is a Californian-based less-than-truckload provider, with revenue of about GBP 757 million per year, we paid a purchase price of around GBP 20 million.

Dicom, our Canadian business is also performing in line with our plan. In May, we spoke about our strategy to expand cross-border. We have some headwinds there. U.K. cross-border volumes have been impacted by the weaker pound, and we have some challenges with the U.S. threat to pull out of the Universal Postal Union. Whilst they now have agreed to remain, there is a lot of work to do to mitigate the resultant price increases, which are due to come into effect in the middle of next year. But overall, we saw good growth, which is reflected in our group numbers. So cross-border revenue was up about 4% and cross-border parcel revenue was up around 7%, efficient.

In May, we talked about our U.K. transformation. The first phase of which was, to lay the foundations for change and to improve performance. We said, we'd improve quality of service. I'm pleased to say we've exceeded our regulated quality of service targets for first and second class letters, delivering one of the best performances since IPO. Quality is a precondition for profitability. Quality first, very important. We also said, we'll improve productivity, and we have done this, improving productivity by 2.2%. This has been achieved despite industrial relation issues.

However, in line with our Union agreement, we have reduced working week by 1 hour, which we have only partly absorbed. This is why it is so important to ensure, we have a funding formula for any future hour reductions. This funding formula is also part of our agreement with the Union.

We are making progress with our transformation journey. We now have 16 small parcel sorting machines with a further 4 being deployed later this year. As a result, parcel automation has increased from 12% last year, close to 26%. We are now trialing the automated movement of containers in our processes units. We are currently spending an estimate of 25,000 hours a day, a day, moving containers mainly by hand. So these trials are key to drive efficiency, lots of potential.

We have given managers full visibility of outdoor activity on our 60,000 daily routes and are in the process of deploying a digital routing tool. We are already in our first parcel hub and are completing the design of parcel automation with suppliers. We have identified the second parcel hub in the Midlands and have found a number of potential sites for our third and final big parcel hub.

There has been a delay with some of the other change in the initiatives. Hours capture tool have been developed. This is basically a system to clock in and clock out, but deployment is being held up. Deployment of our resource scheduler tool, which is to more efficiently match this work with resources, it's also delayed as are the trials we have planned for new delivery methods and our separate van deliveries.

So we have made good progress in some areas. In other areas, we are behind, but remain committed to our plan. Diversified. An important part of our strategy is to diversify the business with the growing proportion of revenue coming from parcels and coming from outside the U.K. If we compare where we are today to 6 years ago at the time of our IPO, you can see the progress, which has been achieved. Revenue from parcel has increased from 48% to 63%, and revenue from outside of the U.K. has increased from 20% to 38%.

GLS is a key part of delivering the diversification. We have a strong track record in GLS of [building] companies, and we will continue to do this.

If I come to the outlook, we remain on track to deliver our profit guidance for this year. And our ambition for the Journey '24 remains the same. We said there would be margin compression in the short term, year 1 and 2 of the plan. This will happen.

Next year, we will see the impact of the Universal Postal Union rate increase. And we are unlikely to see the repeat of the benefits of the 2 elections. But you never know, of course. In May, we also explained that the plan assumed that the GDP will return to a typical growth rate. And that the change will be delivered in partnership with our people and our unions. Clearly, there is a risk to that. The general economic condition are worse, and we are not immune to this. As I said, our letter volume guidance for this year is now 7% to 9% decline. And for next year, 6% to 8%. And Stuart will take you through in more details later on.

Industrial relations are slowing the change. These together could possibly bring us into a breakeven or loss-making situation in the U.K. in 2021. Therefore, it is clear we cannot afford an expensive resolution to the dispute with our unions. There is an urgency to agree on how we deliver the change we need. The longer this takes, the more year 3 of our plan becomes at risk. Well, that said, our balance sheet remains strong. And GLS, our growth engine, is on track to deliver margins of 6% to 7% again this full year, in line with our guidance.

We remain confident that we can pay the 15p dividend out of cumulative cash flow over the 3- and 5-year period.

So in summary, whilst we have work to do to mitigate some of the challenges we face, we have executed our plan in the first 6 months. GLS and U.K. parcel performance was good. Group revenue was up 5.1%. U.K. revenue was up 1.8% despite the letter volume pressure. At the same time, we've delivered great quality of service. Great thanks to all of our people who are out every day, 60,000 homes and delivering this despite what all the weather changes are. I must say, I'm so pleased to see our postmen and women to deliver in all circumstances, this great service.

And at the same time, we saw productivity gains, and we delivered some key milestones in our transformation plan. We always knew it wouldn't be easy, but we are really pleased on our half year performance, and we are confident to deliver full year profit guidance for this year and the 2024 transformation plan.

We are paying the interim dividend of 7.5p, and we remain confident that we can pay the 15p dividend for the full year out of our cumulative cash flow over the 3- and 5-year period. We believe we have the right plan for our people, our customers and our shareholders, a plan that will allow us to grow the business and make Royal Mail strong and successful in the future, very confident.

Stuart, you with the numbers now. Thank you very much.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [3]

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Good morning, everybody. Thank you very much, Rico. As Rico said, I'll take us through the numbers in a little more detail now. Just before I do that, I would like to say thank you to all the managers and all the front line. It's been a really tough half year and actually, we've done a tremendous job with [mate.] Put [my] hat [on to] the COO. I think, the quality has been outstanding and the productivity. I think given the environment we're working in, has actually been really, really pleasing. So a huge thank you to the front line because know a lot of them do watch this.

Now turning to our numbers, starting with the group. I'll just remind everyone, first of all, we present these on an adjusted basis. So that excludes specific items, an example of which is the GBP 50 million of confiners post balance sheet adjusting event. It also excludes the IAS 19 pension charge, but it does include the cash pension charge. So just to remind people of that. A new thing you'll see there at the top of one of the columns says represented. This is, we used to split out transformation costs, we now are not doing that. So all of the costs that you see are including what used to be split out in the transformation.

Just a final thing, the change that you can see the percentage changes as they used to be underlying. Now they're just the raw percentage change.

Now turning to the numbers. As Rico said, revenue is really strong, best for many years, really, really proud of this. It's a cornerstone of the 2024 plan for Royal Mail, is to take us to be a strongly growing group. So a great start on that. But the operating profit, that is down from before GBP 165 million. If you note the other column, the pre-IFRS 16, you can see there's a GBP 7 million difference in operating profit. So not a major difference from the inclusion of IFRS 16 into this.

Margin at 3.2%. Earning per share, [11.1p.] If you just look at the in-year trading cash flow, there's some big swings in there, some big one-offs. If you recall, last year, we had GBP 100 million outflow of a lump sum of back pay. This year, we got a big inflow. We didn't pay any bonuses to management this year. And also, there was a bit of an impact of IFRS 16. When you strip all of that away, the underlying position year-on-year is a GBP 20 million improvement on the in-year trading cash flow on a comparable basis.

Just looking at the net debt, you can see very significant impact of IFRS 16 there, an increase of over GBP 1 billion through the capitalization of the leases. As Rico said at the bottom, you can see we're pleased to announce the interim dividend in line with our policy, 50% of the 15p underpin.

So moving to the UKPIL results. Echoing what Rico said, tremendous revenue performance in the U.K., best for 5 years based on a combination of parcels growth and actually, letters price [on] being active in that space. Costs do remain challenging, particularly in the people area, and I'll expand a bit on that in a moment. Operating profit, GBP 75 million. We signaled margin compression. You can see here, it's down to 2.1%. Within the U.K., there's an IFRS 16 increase of GBP 5 million. I mentioned GBP 7 million in total for the group, GBP 5 million here and GBP 2 million at GLS.

Now looking in more detail, UKPIL revenue. Starting with the parcels, really pleased over 5% increase in revenue, close to 6%, and that's lapping a 6% in the first half last year as well. So a strong performance.

Moving to volumes. The key account parcel space, up 7%. If you go with inside that and look at the tracked parcels, so the product we started introducing around 3, 4 years ago, still growing at over 20%. So really, really strong performance.

International is 2 sides to this. First of all, on import, that's slowing. Weak pound is causing that primarily. If you look at the export, this is where we actually own the customer where we're going out and selling what we can do through our network, GLS in Europe, I see that's growing now. We're really pleased with that because that's something where we feel we can really capitalize on and drive the integration and synergies with the core network. So please, but it does bring cost with it or sending it to another post to deliver in-pay terminal dues, you're paying someone to do that for you. But we're really pleased, growing in that space.

So parcels really strong. If we move to letters, the letters revenue performance is excellent given the environment. I'll draw your attention to the middle box, the GBP 92 million. That is primarily, price. So the price activities we put into the market, we talked about before, they have been sticky, the impact on volume is about 0.2%, 0.3% to generate that GBP 92 million. So we're really pleased with that. The challenging part on the letters, as Rico has trailed, is the volumes were down 8%, outside of the guidance that we gave at the start of this year. So just moving to the next page, I'll talk about that in a bit more detail.

First of all, just to remind you, we did publish a third-party report that talked about letter volumes. To remind you, that said, it would be letter volume decline would be greater than 4% to 6% through the short to medium term. There then be a period of it being back in 4% to 6% around the medium term than in the longer term, less than 4% to 6%.

So as we stood here in May, we agreed with that report. And we did say it, it's going to be outside the 4% to 6% for this year. What we've seen versus May is GDP, is worse than we anticipated if you look through the full year. I think the other impact we've seen is that business uncertainty is worse and has more of an impact than when we stood here in May. And again, that means when businesses are uncertain, the discretionary spend is one of the first things that's pulled, which is primarily marketing, particularly, if there's other cheaper channels. So in that move from May, where we were clear we'd be above the normal range. It has got worse in those key areas. A new one emerged as well, you'll see that residential building. So mail volumes are driven, in part, by people moving houses, buying houses and the churn in that space. Where you get a slowdown in it, as we've seen, we get a slowdown in mail volumes. Again, worse than we anticipated when we stood here in May. So that's why, as we stand here today, and we look forward for this year, we're guiding to 7% to 9%. Just to reiterate, through the first half, it was 8%.

We now look forward to next year. And what are the challenges versus when we stood here before. First of all, I think GDP will continue to be weaker than we anticipated and certainly weaker than the medium term range, which is around 2%. Who actually knows. We get a huge bounce back, this could be much better. But as we stand here today, it looks like it will be weak again. GDPR we'll have all washed through, we'll have well lapped it by then. And business uncertainty, we think, will remain weak, given we think the GDP will remain weak. However, both of those will have moderated from this year. Hence, we're guiding next year for 6% to 8% decline.

Moving on to UKPIL costs, has been a challenging area. Costs overall, up just under 3%. I'll start with the people costs. People costs up around 3%. The driver of that has been the pay to the front line, 2%, pay to the managers, 2.6%. And then, as you know, we granted an hour of a shorter working week last year. That's the equivalent of around 2.6%, 2.7%. When you add all of that up, you need a productivity of over 4% to offset it.

We guided productivity to 2% to 3%. We did not know we weren't going to get there. That was one of the reasons why we saw margin compression over this year and next year. The productivity was 2.2% in the first half, which, as I said, given the environment we're working in, we're really pleased with. Nevertheless, it doesn't offset it and is a cost drag to us.

If you now look further down distribution and conveyance costs. I mentioned before the export volumes are up, they bring with it a cost, and that's where that line comes through. So the increasing export volumes drives increasing terminal dues. We get a bit of a headwind there. Also as fuel hedges unwind and the fuel costs come through a little bit higher, that is where that comes through.

If you look to infrastructure costs, this is largely driven by depreciation. The main issue there being is we see letter volume decline a little bit higher than we thought. The machines depreciate a bit quicker.

And finally, at the bottom, we have other operating costs. This is where we look at a lot of the discretionary spend. We've had some successes in that area, down at around GBP 18 million. Nevertheless, it is a tough environment for costs in this business.

Moving to GLS. Really strong performance, as Rico said. Extremely pleased with this. Back to what we said for 2024, a growing business with GLS really leading the way in that. Revenues up 14%, you back out the acquisitions, up 9%. Costs going up broadly the same as the revenue both with acquisitions up around 14%, you back out the acquisition costs of around 9%. It's a variable cost model, as we've said before.

The margin, as presented here, is 5.9%. If you back out the GBP 2 million of IFRS 16 that's in their, margin's around 5.7%. We're very confident we'll get above the 6% for the full year. The guidance of 6% to 7% is a full year. As you know, we move into the second half of the year, we're a little bit busier. That happens for GLS as well a bit of a operating leverage.

Turning to GLS revenue. As I said, really strong. Just pulling on a couple of key countries. Germany, the biggest country, growth up over 10%. You think of the challenges in the German economy, it's been well trailed. It's under a lot of pressure. And GLS grew 10% in that environment, a really resilient business. It's driven by pricing activities both less price, but also targeted special prices and also, increased export volumes. It's a really strong performance.

Italy, which, as you know, has been one of the stars in the GLS portfolio, the growth is moderating in that country. We're very clear that we are growing on the back of Amazon, but we weren't allocating capital behind it. We knew Amazon would come into the country, which they've done. We knew they'd look to [yield] a way to achieve a solution. So it was right not to allocate capital to them. We've seen them come into every country across Europe, where they have a major opportunity. Nevertheless, Italy is still growing at 6%. Really strong performance, given what we're losing there to Amazon.

France, challenging environment, as you know, but it continues to grow. And it is a key part of our Pan-European network.

USA performing better than we anticipated. So when we sat here and looked at the performance at the start of the year, we're doing better than what we expected. So again, really pleased.

Two standouts, Eastern Europe and Denmark continue to be really incredible places for GLS, doing a tremendous job. So in aggregate, GLS really well, really strong performance.

Looking at the GLS cost line, as I said, variable cost model, primarily if you pick away the acquisitions, up around 9%, broadly in line with the revenue. If you look at the first line of people costs, these are the people employed by GLS, they suffer the same as everyone across Europe. Pressures on labor costs, and that's feeding through there. If you go down to the non people costs and look at that, excluding acquisitions, up around 10%, broadly in line with the revenue growth. If you then start looking in a little bit more detail. Distribution and conveyance costs, that's where the subcontractor costs set as you know, GLS has an outsourced model for delivery, and it's -- that's the line where those costs are. As we've trailed before, continues to be labor costs pressures all across Europe.

If you go to the next line down, the infrastructure costs, brought back -- backing that out, it's around a 12% increase when you back out the acquisitions. So it looks a big number here. But if you take out the acquisitions, we're quite comfortable. We've got a handle and control on it. It's driven primarily by a bit of increase in IT costs. If you go to the very bottom, you can look at other operating costs, you back out the acquisitions, again, it's growing around 10%.

Moving back to the group. Operating profit includes GBP 7 million due to IFRS 16, as I mentioned before, GBP 165 million. You can see the finance costs, they're up year-on-year, GBP 13 million, GBP 12 million of that is related to IFRS 16, the interest on capitalized lease costs.

Come a bit further down, you can then see a profit before tax, which is, IFRS 16 has a hit of GBP 5 million. So on the operating profit, IFRS 16 is favorable GBP 7 million, at this level, profit before tax, it's a hit of GBP 5 million. If you then look to the tax charge, GBP 35 million, that's in line with the mix of earnings we see for the group this year. We expect the rate for the year to be 24%, 25%, again, based on the mix of earnings.

Turning to specific items. First one, to draw your attention to is, the fine at the top of the page. You would have seen that fine is GBP 50 million. It's shown here as GBP 51 million because there's a bit of interest on it. That fine was announced after the closing of 6 months, but it is a post balance sheet adjusting event, hence, we're showing it here.

Next thing to note is the employee free shares down to GBP 4 million, basically negligible in the second half and then it's gone. So that's all washed through. If you keep coming down, the property on disposal of -- profit on disposal of property. That relates to 3 plots down at Nine Elms.

Next one to note is the pension charge to cash difference, GBP 43 million. As I say, that forms part of our adjusted result. You can see at the bottom, the GBP 27 million is the adjusted between the reported and adjusted numbers.

Moving to in-year trading cash flow. If you start at the adjusted EBITDA, trading working capital, some big swings in there. That's where, what I mentioned before, the bonus, lump sum -- sorry, the back pay lump sum paid last year, the GBP 100 million is within the GBP 267 million. Within the GBP 105 million, that's not there, but the GBP 105 million is boosted by the fact there was no bonus paid this year. When you back all of that out, the trading working capital movements year-on-year is basically flat despite the revenue growing by 5%. So a pretty good performance.

The net finance costs, already touched on those, they're up because of IFRS 16. If you come down to the bottom, the in-year trading cash flow, you back out all of those things, all of the one-offs, it's actually up GBP 20 million year-on-year.

In terms of uses of cash, we started the year with a net debt of GBP 300 million. You can see the huge impact of IFRS 16, and that capitalization of the leases over GBP 1 billion. We have inflows from the year trading cash flow and property disposals. The other outflow is, primarily, capitalization of new leases. So leases signed post the start of the year. So that first column, the GBP 1,062 million, that is the restatement of the leases at the start of the year. We then have the GBP 92 million, is primarily, new leases signed this year. You then have a dividend paid. When you back out all of that and look on it on an underlying basis, taking out all of the IFRS 16 impact, the net debts move by GBP 7 million.

So in summary, just to echo what Rico said, I think this has been a really good first half performance, given some challenging environment. Really good group revenue growth, excellent GLS revenue growth, the best U.K. revenue growth for 5 years, so that's letters growth for 5 years. Parcels' outgrowing the market, as we said. So really strong performance on one of the cornerstones of our 2024 journey. So within the U.K., even though we've been having some challenges in the workplace and that industrial relations environment, we've delivered the best quality of service for many, many years. We've also got productivity back on track above the 2%. So again, not insignificant.

If we look at the second half, we have got a bit of a tailwind from an election. However, this is the first time for nearly a 100 years that an election coincides with Christmas. And as you know, we always invest hugely at Christmas to protect the quality. Because of the coincidence with an election there, we're recruiting around about another 5,000 to 6,000 people, we're bringing in. So productivity will take a hit in the second half. But we actually felt it was more important for this group -- for this brand to protect the election, to protect the quality over this period than it was to try and make a short-term gain. So we have invested in that, and it's a very conscious decision. And that will negate the tailwind of the general election.

The other challenges that we have in the second half, letters volumes, we've guided that, that will be worse. We started this year with 5% to 7%, we're now saying it's going to be 7% to 9%. So that will remain a challenge. And our industrial relations environment, Rico talked to Terry this morning. We're going to start the talks next week. Nevertheless, it will be challenging. If you then look further forward, we are confident that we will get GLS back in 6% to 7% margin, and we are confident, and we maintain our ambitions for our 2020 plan.

To that point, we're going to open it up for Q&A. Thank you.

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Questions and Answers

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Mark John McVicar, Barclays Bank PLC, Research Division - Head of European Transportation Research [1]

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Mark McVicar from Barclays. So 2 quick key questions keep coming back from the investors this morning. The first one is, most of the UKPIL is a regulated utility within an allowable return on sales of 5% to 10%, and you're heading to 0% or below. What can you ask the regulator for? And what could the regulator give you to mitigate that situation? That's the first question.

And the second question is, there's been a huge amount of noise and preconditions from -- more from the Union than from you. But if you drill through all of the open letters and the attachments and the lists and all that stuff, what are the 2 or 3 really big things that are the stumbling blocks between you and Terry and the Union in getting things back on track?

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Rico Back, Royal Mail plc - Group CEO & Director [2]

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On regulation, there is a review plan from the regulator, which has taken place. I think, now we expect to finish that one in the next, I'd say, first quarter until the middle of next year. We are talking with the regulator. I think just to be also clear, we are the USO provider, and we intend to stay the USO provider. Very strong statement for us. We have a universal service obligation to deliver 5 days parcels and 6 days letters, but we deliver 6 days parcels and 6 days letters. And if you look where the trend is going to, the delivery is sometimes even 7 days a week, and we have already a share in the Sunday deliveries. And when you deliver a parcel, every letter, which helps this to get the cost down. So a joint delivery is our target. If you look to our revenue streams and our volume streams, 85% of our parcel revenue has been delivered jointly with letters also in the future. So we've got to fight for every letter.

The review from the regulator will look at all the aspects, and we will see what the outcome is. Since we are regulated, we have to [apply to get] the outcome. But they will look at the quality of service targets, for example. We are just helping them to understand that these markets, whatever the regulator say, you win in quality. So a parcel service, and we're saying that 70% of our revenue will coming from parcels in the future, you can only be successful if you are delivering great quality of service. So we don't have a dispute with the regulator. And I think that the USO is helping us to just maintain this strong quality [driven thing] . By the way, the quality of service targets are, I think, the highest in Europe. And Royal Mail has sort of the highest quality of service, which is preconditioned for every business' success. So yes, we are working with the regulator on his review, and we will just deliver a strong quality of service targets.

If you look to the point -- to the -- you're talking about the plan, so can we just get some benefits from it. I think the benefit is if we deliver our plan is, to change Royal Mail from a company, which is 100% focused on letters to a company which has a growth activities and parcels, and we'll just stay on delivering with letters. So therefore, the transformation plan is the key driver to our success. And when I remember, where we have said 6 months ago here, we said that this year will be the year where we sort of prepare everything. That's what we've said, and we have done that. And we knew that when you start to have a change, you got to have a noisy union situation because change is always difficult for people. So therefore, I remember when we had the IPO, the unions opposed, and when you now have a change, it's clear that, that will not go without any sort of noise.

If you ask the question, what are the noises from the Union one of your second part of the questions. I think if I just look at the Union's part, they say the biggest thing is the point of [principle.] So their participation in all the development activities. Because if I look at it, we have delivered everything, which so far is in our agreements, delivered a 5% pay increase was once agreed, a 2%, which was agreed. We have delivered the shorter working week. And not forgetting, please, we had a pension issue, which was a GBP 1 billion pressure on the balance sheet, which is now to our CDC scheme, which we jointly trying to get through U.K. legislation. So our view is we have delivered everything, and I think, when I look at Terry in my first talks to him, which was, I think, probably a week or 2 weeks after my appointment, I think we had one immediately common understanding, the company needs to grow.

So therefore, I am positive that we have a chance now because I've talked to him this morning. It was an early call, and we are back on the table to talk. I mean, the invitation is there. I've seen the email written back to Sally, who is here. We just starting to talk next week, Thursday. And I am confident that the target to grow, we'll find also a way to how we grow. I think that is sort of the dispute. They call a point to principle. That's what they really say. But again, I think you just -- you should not underestimate that. Despite that challenge, which we have with our unions to deliver that quality of service for all of our posties, now again, it's a great privilege to have such a workforce. And this workforce, we -- is convinced that we need to change, and we will find a way to explain what and how to change.

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David Kerstens, Jefferies LLC, Research Division - Equity Analyst [3]

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It's David Kerstens from Jefferies. 3 questions, please. First of all, on the election effect in the first half. I think you said election order was GBP 28 million, but are those 3 points on the volume, which would be around GBP 58 million? If you take that off letter revenue, how much was it really in the first half?

Then with regards to the outlook for the second half of the year. You mentioned the shorter working week. Is it the GBP 300 million to GBP 340 million guidance, does it not include the second hour, which was supposed to come off on October 1. And what are you targeting for productivity improvements in the second half to mitigate that effect?

And then finally, on the longer-term guidance remains unchanged despite increasing letter volume pressure in the first 2 years of the forecast period. What is offsetting that impact with regards to the longer-term outlook?

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [4]

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In terms of the election effect, I don't think we normally give what the impact of an election is. Low single tens of millions is the guidance on that. In terms of the full year guidance of GBP 300 million to GBP 340 million, we've always been clear, the second hour in shorter working week has to be funded. We haven't changed our position on that. We're absolutely clear, it has to be funded. And that means you've got to find enough productivity to ground that to the people and to deliver our commitment of 2% to 3%. That remains the assumption. So absolutely no change on that.

We're not going to give specific guidance for the second half of the year, but the productivity will be worse. It always dips around Christmas anyway because we have an extra 20,000 people in. Well, this year, it's even more than that. So the productivity will be challenging in the second half.

In terms of the long-term and how we can stand by this. Clearly, when you put together a 5-year plan, you don't put every opportunity into it. I think what Rico and I and the management team will be doing, is looking at what are the levers we can pull over the next 6, 12, 18, 24 months to make sure we hit our commitments.

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Rico Back, Royal Mail plc - Group CEO & Director [5]

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Maybe -- it'll be our 6 months in the plan. And what we have said is that we get ready now, starting to deploy next year, and we said there will be a margin compression next year. We said that. Because when you implement a change, you always -- there's sort of an overlapping activity. If you walk through Royal Mail, if I just talk about 25,000 hours per day moving manual yorks moving them manually if you just put down [some magic] in there. So I think there's -- when you walk through it, there's so much potential. And the question is, how quick can you grab that potential. So first year, we said GBP 300 million to GBP 340 million, we delivered on it. We have a different quality of earnings, but the money is there. Cash flow is there. So we are completely in line with the first 6 months.

Despite all the uncertainty we have, we are very committed to the full year outlook. If I remember exactly what we have planned in the second year, we said margin compression, didn't say more because this implementation is there. And if you have a little delay on it, it could be moved into the third year. And I think it is [credible] to tell you there are risk around it. We are still committed to deliver 3- and 5-year guidance. But we just say there's a risk in the third year, but the 5-year is still there. The potential of productivity gains is great and the potential on the revenue is great. And if I look to our revenue lines, better than we have expected it. And if I look what we have done in our, let's say, parcel activities, the new features, new apps, all that stuff is guiding in the direction that revenue will be growing again. And I think if you look at the key issue for a company for me, get the growth, sort out the productivity and then you have a strong set in the market. So the market is there, and we are growing in the market. We're going to sort out our, let's say, cost issues. Jointly, hopefully, with the unions as fast as we can. And then we're back on track.

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David Kerstens, Jefferies LLC, Research Division - Equity Analyst [6]

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Actually, a quick follow-up. Does the lower productivity for the second half also imply you will have lower transformation costs as a result?

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Rico Back, Royal Mail plc - Group CEO & Director [7]

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I think the long-term productivity is about 18% I brought to my head over the complete period. That's the 5-year plan. And we have planned 2% to 3% of the hour [south] , which goes in line with our automation. If you look to how much machines we have in there, increase the automation from 12% to 28% in that 6 months, and it's quite good. So the core activities, which are -- where we are aligned with our unions is to put sorting equipment in our existing mail centers. And just to make it also clear, the plan shows that our existing estate of our 37 mail centers, our 1,200 units, which we are having, is the core. We just put automation in there and take manual handling out of there. And I think to take these automation, that is working according to plan. I mean, we just have to install more -- 4 more machines this year, and we are [just great there.] So I think a lot of things, which we have planned are exactly in line where we are. How would you interpret what we have said, margin compression in the second year? We'd just be open with it and say, the margin compression is there, and we will be back on track if we are committed to 3- and 5-year guidance. That's where we are.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [8]

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And in terms of transformation spend in the second half, we're broadly the same as the first because actually, there's a lot of stuff we can do in the background. And as Rico says, there's a lot of stuff we are doing lending the parcels machines. So it will be [broadly in line] .

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Chi Onn Chu, Deutsche Bank AG, Research Division - Research Analyst [9]

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It's Andy Chu from Deutsche Bank. I have 3 questions, if I may. The first one is a pretty simple one, just in terms of -- Rico, are you yourself going to be meeting with Terry next Thursday?

Secondly, just to come back on the 3-year plan, and I appreciate there's sort of lots of uncertainties. But in terms of what you're pointing the market to this morning in terms of potentially 0 to negative UKPIL operating profit, 2 years' worth of group margin compression. I think that will probably get us to numbers around about a 2% margin in 2021. So just in terms of the step-up to your guidance of more than 4% in 2022, that does indeed seem quite challenging.

And then my third question is on capital allocation. Again, using your sort of guidance for 2020, '21, it feels like the dividend is going to be uncovered for next year. I just wondered in context of not whether you're going to pay the 15p of dividend on a sort of sustainable basis. But in terms of capital allocation, why are you sort of making sort of M&A, particularly in the U.S., where you've kind of struggled and peers have sort of struggled? And just trying to sort of get a sense of cash flow generation, capital allocation at a time where things are quite uncertain.

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Rico Back, Royal Mail plc - Group CEO & Director [10]

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So, Terry, next week, Thursday, I am with investors. So I think next week, Thursday is for Sally and Achim both are here. Very great, great to look forward. And that's clear. And by the way, that's also not a dispute with Terry. So yes, I have the communication, but on Thursday, I'm out on investors, just to be very blunt on it. But I was pleased to have a talk with him. And it was a good talk this morning. So good hope and see if whether the invitation will work. Our target is to have an agreement with the unions. We can't rule [out the rebound,] but it's the target.

The outlook 0 to negative is in line with what we have said, margin compression in the U.K. and if you look to our understanding of the business uncertainty, which we are having here, the letter guidance between has increased, the letter decline guidance has increased. And I think it is just, honest to say, that Royal Mail is not immune to the general economical conditions, which we are having. And the 7% to 9% is what we think is the reality. 6% to 8% next year, it's going down better that [would seem] -- if you look what is interesting, the letter volume -- when you look to letter volume development, you have basically 3 factors of it. One is e-substitution, whatever you see, e-substitution is the issue. That's sort of stable. Since the last 5 years, that's stable. We have some which we call events. And you had an event, which is GDPR effect, which was negative, and you have an event, which is election for the European Union and the election was to come, which is positive. And then you have GDP, which is coming down, which you all know. And that has a direct effect to our letter volumes and the marketing volumes, basically. So if you assume that, that will be a little a bit of weaker, it is correct to just adjust accordingly. Yes, there will be activities for us to do to mitigate it, but we just -- this is from the revenue part of it. There are possibilities to offset it. But letter guidance is, I think, quite correct.

If you look to a PwC report, which has been issued, they say, if you look to the longer term, so third, fourth year, goes down to 4% to 6% and then even flats out to 3% to 4%. That is their view on it. So there is different views. But this -- for the next 2 years, we are quite sure that we should say this. And like we have told you. And for the longer term, if I look at the PwC report, which has been published, we have published that report at the Capital Markets Day, you can see the long-term outlook, how they view it.

The step-up on the 3% to 4% guidance goes in line with what I've said before. The key issue is that we are getting the activities, which we have set up, deployed properly. And the precondition for that is that we could, let's say, grab the efficiency through that one because there's lots of potential. It's not only the manual york movement, which I just said, but especially if you think that we're going to reduce our -- if you look to our plan, we said from 60,000 walks, which we're having today, there'll be 50,000 walks. And then we have 7,000 vans on the street, which means we are growing our existing revenue stream, which is letterboxable items, which is staying into the system. So we're not deleveraging system. We are growing the system, where Stuart always says, more to the core. So we're just moving letter volumes and pass the volumes into the core system. We are not taking part enough in the bigger items. And if you have -- I mean, we have a -- sometimes when you're traveling, you've got a 30 kilo baggage, you know how heavy that is. We don't want that our [posting] are trapped into carrying that. So this needs to go into our van network, which is a new market, which we're trying to run.

So I think the step-up comes when we have a chance to get our activities for the transformation in line. And I'm very, very happy that our Chief Transformation Strategy Officer sitting here, and we're just tracking it now on a monthly basis, all the different activities. So it's all set up now, and we are in the process of starting to deploying things, and you will see the benefits of that one coming. I'm quite sure.

The dividend just to make that also clear. We always said dividend is a cumulative cash flow, 3 and 5 years. It could be that during the first and the second year, there might be, maybe a dip but over the 3 and 5 years, which we stay committed to, we're going to pay [out of] cumulative cash flow. That's our commitment. U.S. is going back on track. We spent GBP 20 million for a GBP 57 million U.S. revenue company, which is a bolt-on acquisition, which is exactly in line with what we have told you. Now I think what I once learned as shareholders hate surprises. So what we said to you is that we keep on having bolt-on acquisition in the U.S., not big ones, but the GBP 20 million investment is sort of something which is in line with that strategy.

So we are building GLS and growing GLS. It's organic growth. It's small acquisitions. There will be acquisitions also in other countries in the GLS area. When we look to Italy, we're always just doing certain acquisitions there. U.S., we said. So there will be small ones, not big ones. And I think if you have a company, which is growing so strong, underlying growth rates by in a way, take acquisitions out of 8%, 9%, you got to be ready to support that growth. This company needs to grow and to expand. We are very careful. When you look to 10 acquisitions, you maybe take 1. Only if it really fits. We are very happy that U.S. is back on track. We have the Dicom, our Canadian one is very good. And if you look to our Italian performance despite the fact that Amazon is moving all the volume to not all of them, but a lot of volume to the post, we're still growing above that -- over 6%, which is -- it's a great, great growth rate.

So GLS is focused on growth and expanding, Royal Mail is focused on turning the U.K. Going first thing back to growth because that's the precondition and then get the transformation done to get the efficiency out in order to make Royal Mail strong. We will have less letters, less -- letters alone or pay our bills. Parcels is growing. And these together will make Royal Mail strong and that's what we see in the future. Have missed anything?

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [11]

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So I think, Andy, just building on it, it is going to be a big step-up, right, from year 2 to year 3. But we're very highly operationally geared. So listen, if there's a small movement, and I think we're really pleased with the revenue in the U.K. given that letters decline. So as that flows through. And also, we didn't put everything in the Capital Markets Day, there's other things we need to look at. Damian.

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Damian Brewer, RBC Capital Markets, Research Division - Analyst [12]

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Damian Brewer, RBC. 3 questions as well, please. First of all, just coming back to U.K. letters, particularly given you've highlighted the relative inelasticity of volume to the price rises you put through. Why aren't you talking about some form price offsetting measure for the increased volume decline in the 2021 year? What's preventing that?

Secondly, if you do move into loss in UKPIL, does that imply your effective tax rate is going to significantly increase, given the position with GLS?

And then thirdly and finally, and I appreciate you've said you're only 6 months into a 5-year plan, but U.K. composite PMI is pretty weak, U.K. consensus GDP outlook certainly is nowhere near 2% for the next several years. So why is the plan still predicated on 2% GDP?

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Rico Back, Royal Mail plc - Group CEO & Director [13]

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Very, very good questions. I'm very happy that Steve is here. You know Steve from our Capital Markets Day. And you have the privilege of answering the first question about letters. I think maybe it's nice to hear directly from the man who is responsible for it.

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Stephen Agar, Royal Mail plc - MD of Consumer & Network Access [14]

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Thank you very much. I'll read the questions about how much price we can take in a declining letter market. The truth is the price elasticities in different segments operate very differently. Last year, we put in roughly 9% into presorted business mail, which has held up pretty well. And we've already announced our price rises for the wholesale letters business for next year, which comes into effect in January. And we're looking at between 5% and 6% next year in that segment as well. So we will take above inflation price rises in parts of the market where we think it can stick.

I think advertising mail is a tricky one. Advertising mail price elasticity is pretty much at 1. If we put up the price of advertising mail, by and large, people just post to budget and we see less. But as we've talked about the volume constraints we're seeing at the moment, and the effect of GDP and the effect of uncertainty is subtly different. When you have lower economic growth across the whole market, it affects roughly all of the letter streams whatever the elasticity and so on, it affects advertising, but it affects commercial transactions, there's less deals being done, therefore less paper is being generated and so on. And when you have market uncertainty, it particularly affects those segments of the market, which are discretionary. If you're sending someone a monthly statement, for as long as you're sending it, it's not discretionary. You'll still have to send that monthly statement. So when we find market uncertainty, it particularly hits discretionary spend, which tends to be advertising and marketing. It's worth remembering that advertising and marketing mail is amongst our lowest average unit revenue product and probably lowest profitability product. So uncertainty, volume decline is not prorated in the way that GDP volume decline is. Actually, you lose volume in advertising mail, but you don't lose as much revenue. You don't lose as much contribution. But I would like to assure you that where we think we can take price to offset volume, we will do that. And we have -- I think it's true to say in all recent years, the revenue decline has always been less than the volume decline. And we're going to make sure that continues for the foreseeable future.

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Rico Back, Royal Mail plc - Group CEO & Director [15]

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Thank you very much. The second question, I think you say loss or breakeven in the U.K. Again, if I look to our plan, which we had 6 months ago, we said, more as in comparison to this year, outlook will be GBP 300 million to GBP 340 million, and we are just confirming the outlook for this year. For the second year, we just said margin compression. We never said how much that will be. I -- we say it could be a breakeven or even loss-making, which is sort of where, we say, if you have a delayed transformation, if we have issues with the implementation and the deployment of tools, we have certain things ready. The question is how fast can you implement? And how are the costs of the implementation? It could be the dip in the next year, which we always have foreseen. So, so far, I think the surprise, which we're having is the letter volume development because of the environment, which we are, let's say, not immune to. The rest is always enlightened and planned. The question how we can step up, again, to our planned numbers in the third year and fourth year, and we get a -- gave a 3- and 5-year guidance. It depends on the speed of the execution of our transformation. And I think the good thing is, and I'm very happy to say that the project teams are set up that the tracking of the activities are set up. I'm pleased that we're back on the table, hopefully, next week with our unions. And it's good that in the transformation, Achim, himself is in there. So that just can convince our people about the necessity. When they see letters are less than parcel somehow they understand that we need to grab the market. Letters all come to us, parcels we have to win. We have -- just don't underestimate that we have more parcels than all competitors together. And if you look to these parcels, we are winning in market share, which is what we are doing right now based on the quality and on the activities going up. This is why I'm convinced we have [chances] in the revenue, and then we getting our transformation up, we will have the step up. I forgot your last question.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [16]

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So the tax rate -- sorry, Damian. Tax rate.

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Rico Back, Royal Mail plc - Group CEO & Director [17]

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Tax rate, yes, yes. That was the one.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [18]

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Yes. It's likely that it will go up just based on the [mix of earnings next year.]

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Damian Brewer, RBC Capital Markets, Research Division - Analyst [19]

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And then the last question was just simply, I appreciate your 6 months into a 5-year plan, but the plan is predicated on the GDP assumption, that's way off what consensus is, what gives you confidence in sticking with that 2%?

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Rico Back, Royal Mail plc - Group CEO & Director [20]

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Well, this is why we have adjusted our letter volume development. That's exactly what we said, 7% to 9%, 6% to 8%. If we believe the PwC report, it will go down to 4% to 6% and then even lower. You have time to do activities. I mean, we, as a management, we are not sitting there. We are not -- we have not achieved the results for the first 6 months. So we're not confident to achieve the full year 6 months. If we don't do anything, if you have revenue decline in certain aspects of other things. So we believe that there are possibilities to offset it and that there are possibilities, like Stuart has said, we have planned everything which we do. So this year is clear. Next year, we'll have the sort of margin compression period. And I think then there's the implementation. The good thing is we are confident with the revenue, and we can confirm that our ambition for 3- and 5-year is there. The risk on the third year, we just tried to tell a little bit about it. [Where] we're depending on it. But we are very sure that our dividends remain stable, which is our new policy based on cumulative cash flow.

Next question? Yes.

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Alexander Irving;Sanford C. Bernstein;Senior Research Associate, [21]

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Alex Irving from Bernstein. If I can ask 2 questions, please. First is on parcel automation. So that was 18% at the end of last year, it's 26% now. Do your productivity comments from today imply this continued sort of linear [rate, please?] Or if not, where do you see that going over time?

My second is on GLS. So regarding the 3 markets that are currently loss-making as far as we are aware. So France, Spain and the U.S., what actions are you taking in these markets, [please] , to improve productivity? And when do you expect these to turn profitable?

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Rico Back, Royal Mail plc - Group CEO & Director [22]

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Well, the parcel machine, we started with 12% automation. And not 16%, we started with 12%. But if you look to the presentation on this on the Capital Market Day was 12% we had.

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Alexander Irving;Sanford C. Bernstein;Senior Research Associate, [23]

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At the end of the year, you exited.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [24]

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It was 12% of the average last year, it's about 18% for the exit. We've now got an exit rate of the 6 months of 26%. We've got 2, 3 more machines to land over the next 6 months. We're then changing, where Achim is leading the change to a different type of small sorting machine. That will kick in a few months after that. And then the large hubs will come on and really make a step change. So this continued kind of growth that we're seeing here from 18% through to 26%, that will continue for the next, probably around 12 months, and then it's dependent on the large machines and the next wave of the small ones coming in.

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Rico Back, Royal Mail plc - Group CEO & Director [25]

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So to your next question. We got the CEO from GLS here. [And a sweet cake.] I like to take you by surprise. Maybe you take the microphone, please.

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James Rietkerk;General Logistics Systems B.V.;CEO, [26]

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We mentioned at the CMD that we had various reasons. So they're all different, the reasons between different markets. If you take the U.S., it was a change in the business model that we implemented. We've done that now, and it's really just bedding that in to the subcontracted drivers. We learned a lot when we did that in Southern California. We're looking at it in Northern California. So we think we're going to do it better than we did in Southern California. It is also we need revenue. So increase in the revenue, did a lot of yield management in the U.S., particularly in PECs, Postal Express, where we took out a lot of the low margin revenue. We need to build that up. So it's a combination of revenue and cost. If you go to Spain, we went through an integration program last year when we integrated Redyser, which is very difficult in terms of combining the 2 networks, that we've substantially done. We now got to sort of get the efficiencies in the network, in the line haul network and also in the hubs to rationalize the hubs to reduce the costs.

If you look at France, we did say that was a longer-term project to improve the profitability, it is going to take time, as we clearly said that at the half year. We've got to get the revenue, part of the revenue is getting the quality right. So a lot of effort is to get the quality right, so we can get the right revenue in. And it is also to sort of change the traffic flow from what we call the non-conveyable parts of the large parcels to the better industrialized parcels. So those are the sort of activities in France. We've also said we're going to look at the management, we have been strengthening the management team over the last year and also on the branding. So it's a combination of factors. France will take longer. I think we're confident on Spain, that we will get to profit this year. And I think we'll also make progress in the U.S., but probably not to breakeven, but we will have reduced the losses this year.

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Rico Back, Royal Mail plc - Group CEO & Director [27]

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And in general, 14.1% revenue increase, 6% to 7% margin is maintained. A key issue. When you have so many countries, things are going up and down and -- but the key issue is if you look to GLS history, it has a trend of delivering, and we are confident that this trend remains intact, and we have delivered for the first 6 months, we will deliver for the full year. And James for the next years, we are counting on it.

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James Rietkerk;General Logistics Systems B.V.;CEO, [28]

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Oh, are you?

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Rico Back, Royal Mail plc - Group CEO & Director [29]

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I think. Yes. Gentleman over there, please? Oh, you have it. Okay, next time. Sorry.

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Samuel James Bland, JP Morgan Chase & Co, Research Division - Research Analyst [30]

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Samuel Bland from JP Morgan. Just one for me. I want to ask whether the -- your understanding of the CWU's position necessarily contradicts with -- or conflicts with the 2024 journey. I think you said earlier you think, primarily the disputes around the point of principle, which wouldn't necessarily imply a kind of financial cost to resolve the current dispute. Is that actually how we should interpret it? Or is there going to have to be some financial resolution as well?

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Rico Back, Royal Mail plc - Group CEO & Director [31]

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The point of principle is, I think, what is the key issue right now. But if you add the point of principles together, there was a view, for example, to go to a shorter working week, second hour. What we have said is, second hour will be granted if you have a funding formula. And for us, it's a key to important to say we have to offset any increase of cost because of the commitments we are making. So we had -- the first hour was a legal binding commitment from 2018, so that was there. The pay was part of the transaction from 18% to 5% and 7%. So that was our legal commitment. And then we had a target to find productivity improvements to offset for the second and third hour. So I think what our petition to the unions is, let's jointly grab our productivity improvement possibilities that we can find the money to improve our financial situation and maintain best terms of condition in the industry, maintain the best pay. Just to be very clear, there is no plan for us to go into the [gig] economy or to rip out the company, we want to make Royal Mail strong in a changing market. And as a union, I'm very sure, a strong company can pay good wages. So therefore, let's get first strong and then debate the other. There is -- this is the conflict. Point of principle means for them, how much do we do jointly? And where the second hour? And I said, let's do jointly, please, the productivity improvements, let's earn the money so we can pay. That sort of is where we are. And this is the debate and well, we would just see how we go on with them, we have some hopes that will work.

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Samuel James Bland, JP Morgan Chase & Co, Research Division - Research Analyst [32]

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Sure. Maybe a quick follow-up. Just the initial proceeds from improved productivity or cost avoidance, do they ultimately flow to employees because you have to reintroduce the shorter working week? And then it's only after that's been achieved. Basically rewards will flow then to shareholders.

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Rico Back, Royal Mail plc - Group CEO & Director [33]

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What I have said is, we can't afford an expensive solution. That's sort of the summary of what we're saying. I mean, we can't negotiate here in public. But our plan says, productivity improvement of 18%. Our plan says 2% to 3% hours out. We need to fund our GBP 1.8 billion investments into automation. And this has been driven mainly by the change processes. If you add that all together, it is more than the 2.2%, which we have now. So our productivity improvement, the 18%, which we have over the plan period has to come from change working. So it should keep on doing what we are doing right now, we won't get there. And I think that is very clear. Our traffic mix has changed. The parcels is going up, parcels are getting bigger. We need to be more flexible, delivering on Sunday, delivering later in the evening. If you look, when you want to grab the parcel market share, which we are right now doing, people ordering between 8:00 sometimes and onto 10:00. We -- 10:00 to midnight? You've got to pick up the stuff in the morning. And basically, when you really look at it, it's the same-day delivery, but that means our people have to start later, be more flexible. If we make all that, we're going to make the money, and then we just can pay. That's sort of it. So our clear target is to deliver the productivity, which we have promised underlying in the Capital Market Day, we can and will do that. I think the gentleman in the back has tried. That's good the last one, and then you, is that okay?

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Arthur David Truslove, Crédit Suisse AG, Research Division - Research Analyst [34]

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Arthur Truslove from Crédit Suisse. So a few from me. So firstly, on the letter volume guidance for FY '21. You've obviously said minus 6% to minus 8%. And I just wondered kind of what the foundation for that forecast is, obviously, quite a long way away and whether you had any sort of color that you could provide us what you're forecasting record at this stage, such a long way out looks like.

Secondly, you obviously avoid GBP 86 million of costs in the first half. I seem to remember last year, when you had the profit warning as sort of a key driver of that was a lack of union cooperation following the negotiations towards the pension deal. I was wondering, yes, in terms of union behavior, [in] cooperation around cost avoidance, when did that sort of change this year? And has there been a serious step down in terms of those costs avoided? And when did that begin?

And finally, I thought your points on residential movement and the impact of that on letter revenues was quite interesting. Are you able to just give us any sort of idea of what proportion of letter revenues are linked to that.

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Stuart Simpson, Royal Mail plc - Chief Finance & Operating Officer and Director [35]

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So -- start off the 6% to 8%. The record of our models is incredibly robust. The challenge we have is what's GDP going to be. And I think what we put out today is, something that says, listen, it looks like the GDP is going to remain weak. That's what we're saying. The key driver of the letters volume decline is actually e-substitution. It's around 8.5%. It's been constant for around 12 years, it remains absolutely where it was. So the thing that really drives you up and down from the 4% to 6%, whether it's favorable to it or worse than it, is what do you think is happening in the overall economy, right? So what we're signaling is, is we've got a view that the economy is going to be weak next year. And hence, we're going to be outside the range. That's the prime driver of that.

In terms of cost avoided -- what was happening last year when we had to give the profit warning. Costs were going in. They were going in to the front line. We've taken out over GBP 30 million in this first half. So it's a complete reversal. That isn't due to any change in behavior from the Union. In fact, things are worse now. It's a reflection that we put in place a management structure to lead the field. And drive the performance despite the environment. So actually, once you've got the Union on side, you're really working together, I'd expect it to be better than that. We've also got flowing through. We did a management restructuring last year. So you've got a big benefit of that flowing through into this year. We've got our normal network review that we managed to land before things really tightened up. So when you put it all together, that's how we've gone from last year, actually not having much in the way of cost avoided in the first half to this first half being pretty much where we said we'd be.

And in terms of the letters revenue movement related to housing. We're not going to tell you precisely what that is because you start getting into decimal points [or] decimal point. But it is something that's been relatively constant for a period of time, for a quite a long period of time. And it's moved outside the band that you'd consider normal. Because of that, you do start seeing an impact. Okay.

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Rico Back, Royal Mail plc - Group CEO & Director [36]

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If you want to have some more details, I think afterwards, Stephen is still there. You just can go through decimal points, but it's sort of -- it's 1% is GDP and 1% is business uncertainty, combined with some activities, which are together -- these are the 2 points, which will just flow through. And then just, hopefully, if you look to trust the PwC report, longer-term, [believe] now. That's where we are, but Stephen is afterwards there for to...

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Alexander Paterson, Peel Hunt LLP, Research Division - Analyst [37]

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It's Alex Paterson from Peel Hunt. Three questions, please. Firstly, could you just clarify, has there been any impact on parcel volume since the CWU vote to strike? Secondly, if the CWU doesn't change its position and adopt the changes that you want, then what? What levers can you pull? Do you rein back on the investment to save cash? And thirdly, Ofcom, obviously ruled against you and you've recognized that provision now, the CAT categorically and comprehensively ruled against you. [Saying whistles case is] without merit, seems like a little bit of a strong statement on that. What do you think they would have to demonstrate above those rulings, if anything, for the them to have a strong case.

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Rico Back, Royal Mail plc - Group CEO & Director [38]

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Any strike announcement is making parcel clients nervous. So they will try to find alternative routes. You can see it also in history, [overall in Royal Mail] now whenever you had a strike announced and people try to find alternatives or set up something different. So clearly, that is not very good. On the other hand, we have a good sales force, we told that we invest into contingency, we told that we just maintain important things. I think our first priority was the election and our second priority is to [put] Christmas. We have put extra, like I said, 26,000 people in place just to make sure that the election is working. Christmas is working. And in case of a problem with the unions, we have a contingency arrangement there. And our clients are trusting us. So yes, we see some effects. It's not without it. But -- and the grand scheme of things, our growth is still there. And we are right now coming into a period where growth is in all the parcel markets. So I think our clients were pleased that we just could find time to pause our debate with the unions, and we're going to look at this next 6 to 8 weeks, which we are having to find a solution starting on Thursday, Sally and Achim. So we are there. Yes, it's damaging. But our contingency arrangements, our investments into it, probably should have hit, partly our productivity number for the second half, but it helps the quality for and the sustainability for our clients, sort of that's what we have done, the first thing.

So if the CWU doesn't come down, if the word if wouldn't be there, we would be all millionaires. So we are targeting to have a sustainable business model. We are targeting to have extra resources in order to maintain a good service quality. We're targeting to have a peaceful relationship with the Union, so to come out of it. I can't rule out that we won't make it. That's what I said. So if there would be, let's say, industrial relations activities, I think our first target is to have contingency arrangement there as much as we can. In order to protect the service for the U.K. public for our clients, that's the first target, which we are having. And at the end, Royal Mail always has found a way to find a settlement with the unions. We know that the unions are part of our company. And like I said before, the good thing, which joins us up is that we want to grow. And to harm a business not to be able to grow harms it at the end of the company to be able to pay the good wages, which we are paying. So I think there's a mutual interest to come to a solution at the end. Like I said, maybe I say it always, it will be a noisy period now, and we are noisy. Good for Christmas and election. Let's see where we end up, hopefully, at the right spot.

On the Ofcom, we were -- we are very disappointed with the results. We are in the process to review all our legal options and activities. And after that, we'll decide what to do. So I can't say more on that one. It's an ongoing legal evaluation.

Next question? No more questions. That's good because we are completely in line with sort of our target timing. I thank everybody very much for coming. It's been a great pleasure from us having you here. Again, I was pleased to confirm the half year performance in line with what we have said. And we're more pleased to confirm that we will deliver what we have promised for the full year. That is for Stuart and me, I think credibility is everything. And this is why we told you there are risks for the second year. According to our plans, we have some mitigation activities in place. We are, again, committing to the 3- and 5-year promises, which we have made as our vision. There might be a delay in the third year, depending on it, we are very, very sure the 5-year guidance is there, the 15p per share and dividend policies underpinned by cumulative inflow cash flow. So thank you very much for staying with us. Thank you for the questions. Have a good day today. Thank you.

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Operator [39]

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This presentation has now ended.