The reality sinks in for AusPost

Any cynicism about the recent spate of predictions of dire outcomes from Australia Post’s management has been dispelled by the reality of its latest results, unless there are structural changes to its community service obligations.

While the government business enterprise did generate a profit of $116.2 million in the year to June, for the first time since it was corporatised in 1989 it incurred a loss in the second half. It lost $105.9m, or $42.9m if restructuring costs were excluded.

That’s despite another really strong result from its non-regulated services, primarily its parcels delivery business, which lifted its earnings before interest and tax for the year 20.8 per cent to $337.5m and stable EBIT of $175m within Australia Post’s retail services division.

The performance of the parcels business was in line with the earnings growth rate the group has been able to generate over the past four years -- the parcels business has doubled its earnings in that period. It's a remarkable achievement for a government business enterprise operating in competitive markets but even if it is maintained, it won’t be sufficient to offset mounting losses in the letters business.

Six years ago the regulated services division made its first loss of $1.7m, but it has subsequently generated losses approaching $750m. Those losses are accelerating. In the year to June, the mail business lost $328.4m.

The causes of the implosion in earnings from its traditional activities are well understood and relate mainly to the impact of digital communications -- email, SMS, Skype and the like -- which has seen an accelerating decline in mail volumes. Letter volumes were down another 5 per cent last financial year and are now back to the levels of the early 1990s.

Australia Post has, in the past six years, lost all of the growth in volumes it has experienced in the preceding 30 years and expects to lose another 30 per cent of the remaining volumes in the next four years.

The impact of that decline has been exacerbated by its community service obligations, which mandate delivery schedules and coverage. The number of addresses to which Australia Post is required to deliver mail keeps expanding at about 150,000 addresses a year, forcing up its fixed cost base even as the volume of mail shrinks.

Australia Post’s chief executive, former senior National Australia Bank executive Ahmed Fahour, has repeatedly warned that the group faces an imminent crisis and that the profits from its commercial services were about to be overwhelmed by the losses from its mail services. That moment appears to have arrived in the second half.

The experience of digital disruption and the logic of Australia Post’s predicament say that its position will continue to deteriorate at a continually accelerating rate as the digitisation of communications continues to expand.

There is no 'solution' to the problem confronting Australia Post. Analysis commissioned by the federal government has confirmed that mail volumes will continue to decline by between 8-11 per cent through to the end of the decade.

One of the surprising 'factoids' within the letters business is that 97 per cent of the volume is originated by governments or business. Both sectors are moving inexorably towards digital channels for their communications, which is why Australia Post believes the volumes will inevitably have a moment where they implode virtually overnight.

Until now, the growth in the parcels business, which has been turbo-charged by the growth in online shopping, has been able to offset the impact of the losses in the mail business. The scale of the losses in mail services is now too large for that to continue.

There’s also a growing threat to Australia Post’s dominance of the parcels sector as its rivals in what is a completely open and competitive sector have focused on the profits it is generating.

Whether it is the big international operators like FedEx or DHL or local competitors like Toll, which has invested heavily to expand its relatively modest share of the parcels market, Australia Post will face increasing competition and will need to continue to invest to protect its position.

If there is no solution to the structural decline of its mail business there are at least measures that could help moderate the rate of decline.

Last year it invested more than $300m in its parcels business to double its processing capacity. The level of capex will fall back this year but there will still inevitably be a continuing need to invest to protect and enhance its position.

Australia Post has openly pleaded to the federal government (which is sympathetic) for changes to its community service obligations. It wants more pricing flexibility (it gained approval for a 10 cent increase in the basic postage rate earlier this year) but, more importantly, the ability to offer a two-tiered, two-speed services with differentiated pricing.

If the federal government were wavering (and Malcolm Turnbull does appear to be on board), the 59 per cent reduction in its dividend from Australia Post to $78.8m might focus its attention. Not only are the dividends disappearing but the prospect of the taxpayer having to write big cheques to Australia Post to cover the losses is now looming large. Changing the CSO requires a change to Australia Post’s regulation rather than legislation.

Australia Post believes that freeing up the CSO would allow it to better manage the decline in mail volumes and avoid the otherwise unavoidable swelling of those losses to $1bn a year in the not-to-distant future. That might provide a pathway to minimising those losses until the traditional mail services become an anachronism in a digital environment and can be shut down without impacting the community.

The alternative, of course, is an open-ended and growing on-budget taxpayer subsidy for the losses flowing from a service that a diminishing proportion of the community actually uses, which would be an irrational outcome.