Close

Download the complete Annual Report and Accounts 2015-16

Build your own report: Select individual sections by clicking the relevant boxes, then click 'Build your own report' to download as a zip file.

Alternatively, you can click any link to view as a PDF (opens in a new browser window).

Click any link to view as a PDF (opens in a new browser window).



See previous section

Financial review

Reported results

Reported results are prepared in accordance with IFRS. Reported Group revenue reduced to £9,251 million (2014-15 £9,328 million). Operating costs before transformation costs increased to £8,766 million (2014-15 £8,717 million). Group operating profit before transformation costs reduced to £485 million (2014-15 £611 million) and operating profit after transformation costs decreased to £294 million (2014-15 £466 million). The reduction was mainly driven by the year-on-year increase in the IAS 19 pension service charge, which is treated as a specific item. The total charge for other operating specific items reduced to £156 million (2014-15 £248 million) mainly due to lower legacy costs. As a result, Group operating profit after operating specific items was £138 million (2014-15 £218 million). Profit before tax reduced to £267 million (2014-15 £400 million) as the prior year benefited from the profit on disposal of the Paddington site. Earnings per share for continuing operations reduced from 32.5 pence to 21.5 pence.

Presentation of results

The remaining commentary in this financial review, unless otherwise indicated, focuses on the adjusted results (continuing operations). The adjusted basis reflects the cash cost of providing pensions, which Management believes is a more meaningful basis upon which to analyse business performance. Movements in revenue, costs, profits and margins are on an underlying basis. This is consistent with the way that financial performance is measured by Management and reported to the Board. Again, this assists in providing a meaningful analysis of the trading results of the Group. The analysis of underlying movements in adjusted results is set out at the end of this section.

Group revenue
(£m)Adjusted 52 weeks ended 27 March 2016Adjusted 52 weeks ended 29 March 2015Underlying change
UKPIL7,6667,757(1%)
GLS1,5801,5579%
Other1514
Total revenue9,2519,3281%

1Other revenue excludes inter-segment revenue of £141 million (2014-15 £152 million)

The main factors impacting revenue in the year are described in the sections entitled ‘UK Parcels, International & Letters (UKPIL)’ and ‘General Logistics Systems (GLS)’. ‘Other’ revenue reduced due to the expiration of a contract to provide facility management services to Post Office Limited.

Group operating costs
(£m)Adjusted 52 weeks ended 27 March 2016Adjusted 52 weeks ended 29 March 2015
People costs(5,199)(5,230)Flat
Non-people costs(3,310)(3,358)1%
Distribution & conveyance costs(1,736)(1,764)2%
Infrastructure costs(995)(1,019)(2%)
Other operating costs(579)(575)(1%)
Total operating costs(8,509)(8,588)Flat

Group operating costs were flat on an underlying basis as lower UKPIL costs were offset by increases in GLS. The main factors impacting operating costs in the year are described in the sections entitled ‘UK Parcels, International & Letters (UKPIL)’ and ‘General Logistics Systems (GLS)’.

Group operating profit after transformation costs
(£m)Adjusted 52 weeks ended 27 March 2016Adjusted 52 weeks ended 29 March 2015
UKPIL417470
GLS117115
Other1710
Group operating profit after transformation costs551595
Margin6.0%6.4%

Group operating profit before transformation costs grew by five per cent. The increase in operating profit from the Other segment relates largely to improved trading performance in Romec Limited. The increase in operating profit from the ‘other’ segment relates largely to improved trading performance in Romec Limited. Group operating profit after transformation costs declined by two per cent as a result of higher transformation costs. Operating profit margin after transformation costs decreased by 10 basis points on an underlying basis to 6.0 per cent.

Specific items

Operating specific items in the period related mainly to the ‘pension charge to cash difference’ of £257 million (2014-15 £129 million) and the Employee Free Shares charge of £158 million (2014-15 £169 million). The difference between the pension charge and cash cost represents the difference between the income statement pension charge rate of 29.8 per cent and the actual cash payments into the schemes. Year-on-year, the increase in the difference has been driven by a decrease in AA corporate bond yields, which increases the income statement charge but not the cash payments. The IAS 19 pension service charge rate for 2016-17 is 28.8 per cent which means that the pension charge to cash difference is expected to reduce to around £230 million. The charge for the Employee Free Shares will reduce over time reflecting the phasing of the charge over the vesting period. For 2016-17 the Employee Free Shares charge is expected to be around £110 million, taking into account the further one per cent of Free Shares to be allocated in due course and an estimate of the level and mix of leavers.

Non-operating specific items include a profit on disposal of property, plant and equipment of £29 million (2014-15 £133 million) mainly arising from the sale of the Croydon Delivery Office. The net pension interest credit was £113 million (2014-15 £75 million). This is higher than the prior year due to the increase in the accounting surplus at 29 March 2015 and the impact of the change in pension accounting policy (see Note 1 to the financial statements). For 2016-17 the pension interest credit is expected to be around £120 million due to the increase in the accounting surplus at 27 March 2016. Profit on disposal of discontinued operations of £31 million (2014-15 £nil) relates to the sale of DPD SL, a subsidiary of GLS Germany.

Net finance costs
RateFacility (£m)Drawn (£m)Facility end date
€500 million bond2.5%3923922024
Revolving credit facilityLIBOR+0.55%1,050-2020-21
Total1,442392
Thumbnail of the Net finance costs table

Net finance costs were £13 million compared with £26 million in the prior year. The reduction was mainly due to improved terms on our borrowing facilities and leases and lower outstanding balances of gross debt following the amendment of the syndicated bank facilities in the prior year.

The blended interest rate on gross debt (including finance leases) for 2016-17 is expected to be approximately three per cent.

Tax
(£m)Adjusted 52 weeks ended 27 March 2016Adjusted 52 weeks ended 29 March 2015
UK tax charge(84)(102)
Foreign tax charge(34)(36)
Total tax charge(118)(138)
Effective tax rate22%24%

The Group effective tax rate on adjusted profit before tax was 22 per cent. The UK effective tax rate of 20 per cent is broadly in UK Corporation Tax rate. GLS effective tax rate of 29 per cent (2014-15 31 per cent) has reduced mainly due to changes in tax territories, particularly Italy.

Earnings per share (EPS)

Basic adjusted EPS for continuing operations was 41.3 pence compared with 42.8 pence in the prior year, reflecting the increase in transformation costs.

Cash flow
(£m)52 weeks 201652 weeks 20152
EBITDA before transformation costs756889
Pension charge to cash difference257129
Adjusted EBITDA before transformation costs1,0131,018
Trading working capital movements(26)(5)
Share-based awards (SAYE and LTIP) charge to cash difference135
Dividends received from associate1-
Total investment(694)(648)
Income tax paid(40)(37)
Net finance costs paid(13)(18)
In-year trading cash flow254315
Other working capital movements617
Cash cost of operating specific items(6)(8)
Proceeds from disposal of property (excluding London property portfolio), plant and equipment3839
Proceeds from disposal of discontinued operations41-
Acquisition of business interests(18)(10)
Cash flows relating to London property portfolio(23)100
Free cash flow292453

2 52 weeks 2015 has been restated to move change in GLS client cash of £6 million from ‘Trading working capital movements’ to ‘Other working capital movements’ and to extract £10 million in respect of ‘Acquisition of business interests’ from ‘Growth capital expenditure’ within ‘Total investment’.

Adjusted EBITDA before transformation costs was broadly flat at £1,013 million.

Trading working capital movements were an outflow of £26 million largely as a result of the change in international sales mix, a trend which is expected to continue.

In-year trading cash flow was an inflow of £254 million, £61 million lower than the prior year mainly driven by an increase in investment.

Investment
(£m)52 weeks 201652 weeks 2015
Growth capital expenditure(253)(168)
Replacement capital expenditure(208)(252)
Transformation operating expenditure(233)(228)
Voluntary redundancy – ongoing(159)(62)
Voluntary redundancy – management reorganisation-(96)
Project costs(72)(61)
Business transformation payments(2)(9)
Total investment(694)(648)
Proceeds from disposal of property (excluding London property portfolio), plant and equipment3839
Net investment(656)(609)

Total gross investment increased to £694 million, mainly due to an increase in expenditure on projects and initiatives to support growth. Growth capital expenditure increased by £85 million with the principal investments being in relation to parcel IT systems, parcels automation, the purchase of new PDAs and investment in GLS. Replacement capital expenditure decreased by £44 million. The main investment in the period related to IT, in particular IT transformation, with reduced spend on vehicles. Transformation spend increased by £5 million to £233 million, mainly as a result of increased spend in relation to project costs largely due to the cost avoidance programme. Total spend in relation to voluntary redundancy was in line with the prior year. Proceeds from the disposal of property, plant and equipment (excluding London property portfolio), mainly relating to the sale of the Croydon Delivery Office, were £38 million, giving a total net investment of £656 million. This was slightly higher than expected due to timing of certain projects.

Tax payments of £40 million largely relate to amounts paid in Europe. In the UK, we continue to be able to offset the majority of taxable profits with capital allowances and brought forward losses. This is now expected to normalise in 2018-19, mainly due to relief available from additional Employee Free Shares allocations.

Cash cost of operating specific items related to legacy and legal costs. Going forward, the Company is liable to pay National Insurance contributions on any Free Shares that are sold by employees prior to the end of each of the Share Incentive Plans’ five year terms. The amounts and timing of any such cash payments are uncertain but will be treated as operating specific items.

As previously reported, on 31 March 2015 GLS Germany sold its entire holding in its subsidiary DPD SL resulting in proceeds from sale of discontinued operations of £41 million.

Acquisition of business interests cash ows of £18 million relate to amounts paid in respect of investments made in the year, mainly NetDespatch Ltd, Mallzee Ltd, Interso Systems & Programming Limited and acquisitions in GLS, including deferred consideration paid in relation to acquisitions made in prior periods.

Cash flows relating to the London property portfolio of £23 million largely relate to remediation work, reprovisioning costs and professional fees at the Nine Elms and Mount Pleasant sites.

Net debt
(£m)Balance sheet category52 weeks 201652 weeks 2015
Obligations under finance leasesCurrent liabilities(84)(93)
Interest-bearing loans and borrowingsNon-current liabilities(392)(366)
Obligations under finance leasesNon-current liabilities(136)(179)
Total gross debt(612)(638)
Cash and cash equivalents368287
Cash at bank and in handCurrent assets185127
Client cashCurrent assets1320
Cash equivalent investmentsCurrent assets170140
Financial assets – short-term depositsCurrent assets-56
Pension escrow investments (RMSEPP)Non-current assets2020
Net debt carried forward(224)(275)

Net debt was £224 million at 27 March 2016, £51 million lower than at 29 March 2015. The decrease in net debt was driven by the in-year trading cash flow and proceeds from the disposal of assets, partially offset by dividend payments to equity holders of the parent Company.

We continue to target investment grade credit metrics, that is, no lower than BBB- under Standard & Poor’s methodology.

A reconciliation of net debt is shown below.

(£m)52 weeks 201652 weeks 2015
Net debt brought forward(275)(555)
In-year trading cash flow254315
Other working capital movements617
Cash cost of operating specific items(6)(8)
Proceeds from disposal of property (excluding London property portfolio), plant and equipment3839
Proceeds from disposal of discontinued operations41-
Acquisition of business interests(18)(10)
Cash flows relating to London property portfolio(23)100
Dividends paid to equity holders of the parent Company(213)(200)
Dividends paid to non-controlling interests(7)(1)
Decrease in finance lease obligations (non-cash)-8
Foreign currency exchange impact(21)20
Net debt carried forward(224)(275)

Pensions

The IAS 19 pension position at 27 March 2016 was a surplus of £3,430 million, compared with a surplus of £3,049 million at 27 September 2015 and £3,367 million (restated – see Note 1 to the financial statements) at 29 March 2015. The IAS 19 accounting position and key assumptions for the valuation are provided in Note 10.

The process for the triennial valuation of the Royal Mail Pension Plan (RMPP) at 31 March 2015 has commenced and the outcome will be announced in due course. Royal Mail Senior Executives Pension Plan (RMSEPP) triennial valuation at 31 March 2015 has been completed, based on the assumptions agreed as part of the Funding Agreement made between the Company and the Trustee in 2013. If the assumptions used for the 2012 triennial valuation of the RMPP and the 2015 triennial valuation of the RMSEPP are rolled forward to 31 March 2016, the combined actuarial surplus would be £1,777 million, compared with £1,525 million at 30 September 2015 and £1,793 million at 31 March 2015. It is this basis that the Pension Trustee and the Company use to assess the ongoing funding needs of these schemes. To support the Company’s commitment that, subject to certain conditions, the RMPP will remain open to defined benefit accrual until at least March 2018, the Trustee has hedged a large proportion of the interest and inflation exposure on this expected future service benefit accrual. The Trustee increased this hedging further during 2015-16, and on an actuarial basis the amount of the surplus at March 2016 relating to the liabilities hedged in advance of those accrued to the same date, was approximately £550 million. This element of the surplus will unwind over time.

Under the 2012 triennial valuation of the RMPP, the Company agreed to pay ongoing cash contributions of 17.1 per cent of pensionable pay until 2018. At that time, this amounted to around £400 million per annum. This was made possible by the creation of an actuarial surplus of £1.6 billion as a result of the Pensions Reform in 2013. Without this surplus, the Company contributions required would have been around £700 million per annum, or 30 per cent of pensionable pay. Accordingly, the surplus was expected to decline over time.

Although market conditions for defined benefit schemes have been very volatile over the past 12 months, the funding position of the RMPP at the end of the 2015-16 financial year is broadly in line with that at the end of 2014-15, largely due to increases in the market value of gilts and derivative assets held to hedge interest rate and inflation risks. We continue to expect that the RMPP actuarial surplus will reduce over time, although the pace of this reduction will only be confirmed once the 2015 triennial valuation process has been concluded.

As part of the March 2012 actuarial valuation, the Company agreed to pay additional contributions of up to £50 million a year from April 2016 onwards if the Trustee considers these necessary to maintain the Plan’s projected funding position in March 2019. Until the Trustee has carried out its assessment of liabilities at 31 March 2016, we will not know if any payment will become due for 2016-17.

Dividends

The final dividend of 14.3 pence per share in respect of the 2014-15 financial year was paid on 31 July 2015, following shareholder approval.

The Board is recommending a final dividend of 15.1 pence per ordinary share, payable on 29 July 2016 to shareholders on the register at the close of business on 1 July 2016, subject to shareholder approval at the AGM on 21 July 2016. This gives a total dividend for the year of 22.1 pence, an increase of five per cent.

As previously stated, given the seasonality of the Group’s business, the Board would expect to pay an interim dividend each year equal to approximately one-third of the prior year’s total dividend and to set the final dividend for each year in light of the full year performance of the Group.

Property

We continue to adopt a flexible approach in relation to our large London development sites at Nine Elms and Mount Pleasant and continue to explore options to realise value from them. Proceeds from the sale of the Paddington site will be reinvested into these larger sites to enable development.

The Group is exposed to commodity and currency price risk. The Group operates hedging policies which will be described in the Notes to the financial statements.

The forecast diesel and jet commodity exposures in UKPIL are set out below together with the sensitivity of 2016-17 operating profit to changes in commodity prices and fuel duty.

Forecast total costFuel duty (incl irrecoverable VAT) - not hedgedUnderlying commodity exposure(incl irrecoverable VAT)Underlying commodity volume hedgedResidual unhedged underlying commodity exposure (incl irrecoverable VAT)Impact 2016-17 operating profit of a further 10% increase in commodity priceImpact on 2016-17 operating profit of a further 10% increase in fuel duty
2016-17 Exposure£m£m£m%£m£m£m
Diesel1489454903-(9)
Jet8-8772-n/a
Total1569462885-(9)
Thumbnail of the The forecast diesel and jet commodity exposures in UKPIL table

As a result of hedging it is anticipated that the diesel commodity cost for 2016-17 will reduce by £12 million. Without hedging the cost reduction would have been £31 million (based upon closing fuel prices at 27 March 2016). Due to the policy of hedging in advance, the current oil prices will result in anticipated lower effective diesel commodity cost in the future.

The UKPIL and Other business units’ functional currency is Sterling, while GLS’ functional currency is the Euro. Therefore the translational exposure to the Group’s operating profit relates to GLS’ profits.

In 2015-16, the average exchange rate between Sterling and the Euro was £1/€1.37 representing an eight per cent strengthening in Sterling compared with £1/€1.27 in 2014-15, which resulted in a £8 million reduction in GLS’ reported operating profits.

The Group manages its interest rate risk through a combination of fixed rates loans and leasing, floating rate loans/facilities and floating rate financial investments. At 27 March 2016, all of the gross debt of £612 million was at fixed rate to maturity.

Counterparty risk is managed by limiting aggregate exposure to any individual counterparty based on their financial strength.

Events after the reporting year

Romec Limited (Romec) – acquisition of 49 per cent shareholding
On 31 March 2016, Royal Mail Group Limited (RMG), the main operating subsidiary of Royal Mail plc, acquired the 49 per cent of shares in Romec that it did not already own, from ENGIE (formerly Cofely Workplace Limited), making RMG the sole shareholder of Romec. The financial terms of the acquisition are not considered by Management to be material in the context of the Group as a whole.

Settlement of French Competition Authority fine
Following the results of an investigation by the French Competition Authority (Autorité de la Concurrence) in respect of alleged breaches of antitrust laws by one of its subsidiaries, GLS France, a settlement amount of €55 million was paid by the Group on 15 April 2016. This amount is fully provided for in the Group financial statements at 27 March 2016 and at 29 March 2015.

Auditor
Following the audit tender process explained on page 50 of the Annual Report and Financial Statements 2014-15, the proposal to appoint KPMG LLP as external auditor was approved by shareholders at the 2015 AGM.

Underlying change
Movements in revenue, costs, profits and margins are shown on an underlying basis. Underlying movements take into account differences in working days in UKPIL (2015-16 303; 2014-15 304) and movements in foreign exchange in GLS (2015-16 £1/€ 1.37; 2014-15 £1/€ 1.27). In addition, adjustments are made for non-recurring or distorting items, which by their nature may be unpredictable. For volumes, underlying movements are adjusted for working days in UKPIL, and exclude elections in letter volumes. For 2016-17, the estimated impact of working days in UKPIL is around £65 million (2016-17 305.6 days).

(£m)Adjusted 2015-16Adjusted 2014-15Working days (UKPIL)Foreign exchange (GLS)Underlying 2014-15Underlying change
Revenue
UKPIL7,6667,757(26)-7,731(1%)
GLS1,5801,557-(109)1,4489%
Other514--14n/m
Group9,2519,328(26)(109)9,1931%
Costs
Group
People(5,199)(5,230)-25(5,205)Flat
Non-people costs(3,310)(3,358)-76(3,282)1%
Distribution and conveyance costs(1,736)(1,764)-66(1,698)2%
Infrastructure costs(995)(1,019)-7(1,012)(2%)
Other operating costs(579)(575)-3(572)1%
Operating costs before transformation costs(8,509)(8,588)-101(8,487)Flat
UKPIL
People(4,764)(4,789)--(4,789)(1%)
Non-people costs(2,294)(2,353)--(2,353)(3%)
Distribution and conveyance costs(776)(821)--(821)(5%)
Infrastructure costs(890)(919)--(919)(3%)
Other operating costs(628)(613)--(613)2%
Operating costs before transformation costs(7,058)(7,142)--(7,142)(1%)
GLS
Operating costs(1,463)(1,442)-101(1,341)9%
Profit, margins and EPS
Group
Operating profit before transformation costs742740(26)(8)(706)5%
Margin8.0%7.9%7.7%30bps
Transformation costs(191)(145)--(145)
Operating profit after transformation costs551595(26)(8)561(2%)
Margin6.0%6.4%6.1%(10bps)
Profit before tax538569(26)(8)535-
Tax(118)(138)(130)-
Profit for the period420431405-
Profit attributable to the Group413428402-
Group earnings per share (pence)41.342.840.2-
UKPIL
Operating profit before transformation costs608615(26)-5893%
Margin7.9%7.9%--7.6%30bps
Transformation costs(191)(145)--(145)
Operating profit after transformation costs417470(26)-444(6%)
Margin5.4%6.1%5.7%(30 bps)
GLS
Operating profit before transformation costs117115-(8)1079%
Margin7.4%7.4%7.4%Flat
Thumbnail of the Underlying changes table
Notes
  1. 52 weeks 2015 has been restated to move change in GLS client cash of £6 million from ‘Trading working capital movements’ to ‘Other working capital movements’ and to extract £10 million in respect of ‘Acquisition of business interests’ from ‘Growth capital expenditure’ within ‘Total investment’

Principal risks

The Corporate Governance section describes in detail how the Group manages its risk from the Group Board level, its respective sub-committees and throughout the organisation.

The table below details each principal business risk, those aspects that would be impacted were the risk to materialise, our assessment of the current status of the risk and how the Group mitigates it.

Key

Relative severity

Change during the year

Speed at which the risk could impact

Principal risk

Status

How we are mitigating the risk

Principal risk

Changes in market conditions and customer behaviour

The industry sectors in which we operate remain highly competitive, with customers demanding more and our competitors responding quickly to these changing demands.

Principal risk

Status

How we are mitigating the risk

Customer behaviour and Royal Mail’s responsiveness to market changes

Principal risk

Customer behaviour and Royal Mail’s responsiveness to market changes

Changes in customer behaviour, and changes to the markets in which the Group sells its products and services, could impact our forecast rates of decline and growth of letter and parcel volumes respectively.

There is a risk that our product offerings and customer experience may not adequately meet evolving customer needs, or that we are unable to innovate or adapt our commercial and operational activities quickly enough to respond to changes in these markets.

Status

The parcels sector is undergoing rapid and profound change. Competition in the UK domestic and international markets continues to intensify, with competitors offering innovative solutions that include convenient, reliable delivery and return options, and improved tracking facilities. Capacity expansion in the sector continues to exert downward pressure on prices.

In the parcels business, disintermediation in the on-line marketplaces may divert our business to other carriers or collection providers.

We expect the letters sector to remain in structural decline, in the medium-term, driven by the growth in mobile and online advertising, and e-substitution.

There is a continuing requirement to invest in growth and innovation to meet these challenges in the marketplace.

How we are mitigating the risk

  • We use continuous in-depth market monitoring and research to track how well we match our customers’ needs, including relative to our competitors, and to predict volume trends.
  • We are investing in introducing, at pace, new and improved products and services that: enhance customers’ online and delivery experience; expand our core offering to small and medium-size businesses and marketplace sellers; and extend our product coverage. We target investments that will extend our value chain offer and increase our presence in faster growing areas of the parcels sector.
  • We promote the value of letters to customers through our MAILMEN initiative for marketing mail, Keep Me Posted and other campaigns, and innovations such as Mailmark®.

Principal risk

Status

How we are mitigating the risk

Economic environment

Principal risk

Economic environment

Historically there has been a correlation between economic conditions and mail volumes. Slowing economic growth could impact our ability to maintain and grow revenue, either through reduced volumes or by encouraging customers to adopt alternative service options for sending letters and parcels.

Status

The outlook for economic conditions in the UK is broadly in line with our planning assumptions, but uncertainty around the outlook has increased.

Economic growth in the Eurozone is more moderate and recovery remains fragile. Low growth or recession in Europe could impact our international parcel volumes, including those handled by GLS.

How we are mitigating the risk

  • We have a robust modelling and forecasting framework that uses a range of quantitative and qualitative approaches to provide early warnings of changes to overall volumes and the profile of letter and parcel business, and to assess the effect of our pricing structures. We have a programme of regular reviews of outcome data compared to forecast, and recalibration and upgrade of these models.
  • We have a challenging cost avoidance programme in place in response to revenue headwinds.
  • We are pursuing initiatives to find new areas of growth, such as fleet maintenance services and leveraging data assets.

Principal risk

Status

How we are mitigating the risk

Principal risk

Pension risk

The Group continues to operate a defined benefit pension scheme, the Royal Mail Pension Plan, open to accrual for existing members.

Principal risk

Status

How we are mitigating the risk

Affordability of the defined benefit pension scheme

Principal risk

Our ongoing ability to maintain the Royal Mail Pension (Plan) in its current form is subject to financial market conditions.

Status

As part of the Pension Reform in 2013, we committed, subject to certain conditions, to keep the Plan open until at least March 2018.

Current financial market conditions suggest that keeping the Plan open to accrual in its current form beyond 2018 will not be affordable.

How we are mitigating the risk

  • The Plan is hedged against future interest rate and inflation rate exposures, and we are confident that this will enable us to meet our commitment to keep the Plan open to accrual up to March 2018.
  • We are in discussions with the unions, and are developing proposals for sustainable post-March 2018 pension arrangements.

Principal risk

Status

How we are mitigating the risk

Principal risk

Business transformation

Royal Mail must continuously become more efficient and flexible in order to compete effectively in the letters and parcels sectors.

Principal risk

Status

How we are mitigating the risk

Efficiency

Principal risk

Efficiency

The success of our strategy relies on the effective control of costs and the delivery of efficiency benefits.

Status

We continue to make efficiency improvements. Our productivity improvement is within our target range, and through our strategic focus on costs we have reduced our underlying UKPIL operating costs, before transformation costs, by one per cent.

How we are mitigating the risk

  • We have a strategic programme of cost avoidance, involving approximately 70 projects targeted to avoid around £500 million of annualised costs by 2017-18.
  • Our Agenda for Growth agreement with the CWU, supported by the Together for Growth training programme, and a joint mediation process, which facilitates a collaborative approach to improving efficiency at a local and national level.
  • We have redefined and rolled out across the network core Operations Standards that are based on best observed practice. A programme to enable better alignment of resourcing and workload is also being implemented across the Delivery Office network.
  • We are simplifying our operational management structure and have programmes of activity in hand to support operational managers in improving efficiency.
  • We continue to reduce levels of Lost Time Accidents and other sick absence through a positive focus on compliance with attendance management procedures, safety and wellbeing support.

Principal risk

Status

How we are mitigating the risk

Attracting and retaining senior management and key personnel

Principal risk

Attracting and retaining senior management and key personnel

Our performance, operating results and future growth depend on our ability to attract and retain talent with the appropriate level of expertise.

Status

Turnover in senior and key personnel has been at normal levels for the business during the year, but this remains an inherent business risk.

How we are mitigating the risk

  • The Group’s remuneration policy sets out that the overall remuneration package should be sufficiently competitive to attract, retain and motivate executives with the commercial experience to run a large, complex business in a highly challenging context.
  • We operate a succession planning process and have in place talent identification and development programmes.

Principal risk

Status

How we are mitigating the risk

IT transformation

Principal risk

IT Transformation

The scale and complexity of our IT transformation programme and the ongoing requirement for effective management of the transition are sources of risk to its successful delivery.

Failure to improve our IT systems or successfully implement the IT transformation programme could increase the risk of: security breaches and attacks; a material adverse effect on the Group’s operations; and inability of IT systems to support the business plan.

Status

We have made significant progress in delivering the IT transformation programme. Infrastructure changes and transition to new providers are close to completion.

This will provide us with an effective technical infrastructure that, going forward, better supports both routine functional activity and business growth.

How we are mitigating the risk

  • In view of the size and complexity of the transformation programme, we have, throughout its lifecycle, strengthened standard programme management and governance disciplines to provide intensive focus on key aspects; completing residual elements of the transition is now the primary focus.

Principal risk

Status

How we are mitigating the risk

Principal risk

Regulatory and legislative environment

The business operates in a regulated environment. Changes in legal and regulatory requirements could impact our ability to meet our targets and goals.

Principal risk

Status

How we are mitigating the risk

Fundamental review of postal services regulation

Principal risk

Fundamental review of postal services regulation

In June 2015 Ofcom announced a fundamental review of the regulation of Royal Mail. The review, currently in progress, incorporates previously announced reviews into efficiency, parcels and access pricing. It also examines: what changes to the overall postal regulatory framework might be appropriate to secure the Universal Postal Service; Royal Mail’s wholesale and retail pricing; and whether the current level of commercial flexibility allowed to Royal Mail remains appropriate, and, if not, whether additional wholesale or retail price controls should be introduced.

A regulatory system or approach that applies restraints to Royal Mail’s ability to compete for traffic to support the costs of the Universal Service network, or imposes operational requirements not applied generally to the industry, may impact our revenues, our ability to compete in the highly competitive industry sectors in which we operate, and ultimately our ability to deliver the Universal Service on a sustainable basis.

Status

This is a new risk that has emerged during the year. It was disclosed in our financial results for the half year ended 27 September 2015.

Ofcom has stated that it expects to complete the process and have a regulatory framework in place in early 2017.

There is an ongoing Competition Act investigation by Ofcom relating to certain of our access pricing proposals in January 2014, which we suspended without implementing and subsequently withdrew. We dispute the allegations and are robustly defending the investigation.

How we are mitigating the risk

  • We have made comprehensive submissions to Ofcom as part of its initial call for evidence and we have ongoing engagement with Ofcom to build on the response to issues raised.
  • Our response to the proposal will be shaped by the detail of the proposal and any threat it may present to our ability to compete effectively, and to the sustainability of the Universal Service. We will seek to work with Ofcom to protect the Universal Service.
  • We have a strategic focus on cost avoidance and delivering efficiency improvements, as noted against the Efficiency risk in the Business transformation section above.
  • We have made a detailed submission to Ofcom in relation to its Competition Act investigation.

Principal risk

Status

How we are mitigating the risk

VAT status

Principal risk

VAT status

The Value Added Tax (VAT) treatment of Royal Mail’s services, including exemption applying to certain products, is under threat in two areas:

  • The EU has published a proposal for a Vouchers Directive, which could adversely impact Royal Mail’s VAT position, if as a result, postage stamps were treated in the same way as other vouchers; and
  • The European Commission is reviewing a number of VAT exemptions, including the exemption applying to postal services. Although Royal Mail could benefit from greater recoverability of VAT on costs if the VAT exemption for postal services was removed, the cost to customers who cannot reclaim VAT would be likely to increase.

The VAT exemption applying to mandated access services has also been under threat, with HMRC’s implementation of VAT legislation on these services subject to a judicial review.

Status

The proposed Vouchers Directive is under discussion in Europe. The outcome remains uncertain.

The European Commission has published details of responses to its consultation about the future of VAT exemptions, but there has been no indication of the likely outcome or timescale of the review.

The appeal against the decision that HMRC had correctly implemented VAT legislation in respect of exemption applying to mandated access services has been withdrawn and the matter is now concluded.

The improved risk trend reflects our re‐assessment of the potential impact of these issues.

How we are mitigating the risk

  • We continue to liaise with HM Treasury and HMRC to seek to minimise any adverse impact of the proposed Vouchers Directive.
  • We are monitoring and continue to feed into discussions with the European Commission on potential developments in VAT legislation.

Principal risk

Status

How we are mitigating the risk

Employment legislation and regulation

Principal risk

Fundamental review of postal services regulation

Changes to laws and regulations relating to employment (including the interpretation and enforcement of those laws and regulations) could, directly or indirectly, increase the Group’s labour costs, which, given the size of the Group’s workforce, could have an adverse effect on the Group.

Status

Recent case law has suggested that regular overtime and commission payments should form part of holiday pay calculations. The legal position remains unclear as case law is still evolving in this area.

Other risks to our cost base associated with employment legislation have emerged and were disclosed in our financial results for the half year ended 27 September 2015. These are:

  • Proposal for an Apprenticeship Levy. Draft legislation sets the levy at 0.5 per cent of payroll costs, applicable from April 2017.
  • Proposed changes to National Insurance (NI) on termination of employment have been announced, which will increase employers’ NI costs from April 2018.
  • The Government has consulted on how pensions tax relief is provided, but has not proposed changes at this time. If changes are proposed in the future, they could have a significant impact on the cost of providing pensions.

How we are mitigating the risk

  • We continue to monitor developments in case law relating to the application of the Working Time Directive in respect of holiday pay calculations. Based on our estimates of the potential financial impact, we believe that we have made sufficient provision for any historic liabilities that may arise.
  • We liaise with the CBI, HMRC and HM Treasury to influence employment tax developments and minimise the impacts for Royal Mail as far as possible.

Principal risk

Status

How we are mitigating the risk

Cyber security

Principal risk

Cyber security

We are subject to a range of regulations and contractual compliance obligations around the governance and protection of various classes of data, and are susceptible to cyber attacks that could threaten the confidentiality, integrity and availability of data in our systems.

A cyber security incident could also trigger material service interruption.

Either of these outcomes could result in financial and reputation damage, including loss of customer confidence.

Status

While no material losses related to cyber security breaches have been suffered, given the increasing sophistication and evolving nature of this threat and our reliance on technology and data for operational and strategic purposes, we now consider it is appropriate to include this as a principal risk.

How we are mitigating the risk

  • As external threats become more sophisticated, and the potential impact of service disruption increases, we continue to address our ongoing investment in cyber security. We take a comprehensive view of cyber security and continually review our resilience in light of the changes and threats we face.

Principal risk

Status

How we are mitigating the risk

Principal risk

Industrial relations

There is extensive trade union recognition in respect of our workforce in the UK, with a strong and active trade union which, historically, has used industrial action to lever benefits for their members.

Principal risk

Status

How we are mitigating the risk

Industrial action

Principal risk

There is a risk that one or more material disagreements or disputes between the Group and its trade unions could result in widespread localised or national industrial action.

Widespread localised or national industrial action would cause material disruption to our business in the UK and would be likely to result in an immediate and potentially ongoing significant loss of revenue for the Group. It may also cause Royal Mail to fail to meet the Quality of Service targets prescribed by Ofcom, leading to enforcement action and fines.

Status

The Agenda for Growth agreement developed jointly with the CWU represents a fundamental change in our relationship with the CWU, and promotes stability in industrial relations.

However, industrial relations is an inherent risk within our business: we are negotiating a new pay deal for 2016-17, the Pension Plan affordability is under discussion, and the increasingly competitive environment and other sources of pressure on costs and efficiency may put the stability of our industrial relations under strain.

How we are mitigating the risk

  • Our Agenda for Growth agreement with the CWU provides a joint commitment to improved industrial relations, and to resolving disputes at pace and in a way that is beneficial to both employees and Royal Mail.
  • As part of our collaborative approach with the CWU, the Agenda for Growth is supported by our Together for Growth programme, an industrial relations and business skills package for managers and CWU representatives designed jointly to improve the way that managers and unions work together. A resolution process for local disputes uses trained mediators nominated by and representing both the CWU and the business.
  • The Agenda for Growth agreement has legally binding protections for the workforce in respect of future job security and our employment model, but which can be rescinded in the event of national industrial action.

Viability Statement

The Directors have assessed the viability of the Group as part of their ongoing risk management and monitoring processes.

While the Directors have no reason to believe that the Group will not be viable over the longer term, they consider the three financial years to March 2019 to be an appropriate planning time horizon to assess Royal Mail’s viability and to determine the probability and impact of our risks. This is the same time frame of our existing medium-term planning cycle.

The Directors considered all principal risks set out in the Principal risks section but focused on those that could have a plausible and severe financial impact over the plan horizon. In particular they considered the potential impact of industrial action and deteriorating economic and market conditions.

The risks were quantified to create a downside scenario that took into account the levels of committed investment and expenditure, as well as other short-term cost and cash actions which could mitigate the impact of the risks. Consideration was also given to the large fixed cost base required to deliver the Universal Service Obligation in its current form. The downside scenario was tested to determine whether the Group would remain solvent.

The Directors have made the assumption that the RMPP funding rate remains unchanged from 2015-16.

Based on the results of their analysis, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period to March 2019.

See next section