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Next - A disappointing end to the year

Steve Clayton | 5 January 2016 | A A A
Next - A disappointing end to the year

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Next plc Ordinary 10p Shares

Sell: 8,082.00 | Buy: 8,086.00 | Change -114.00 (-1.39%)
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Next has released a Q4 trading statement covering the all-important Christmas trading period, the first major retailer to do so. Unsurprisingly, sales have been weaker in the final quarter, in response to the warm weather. Disappointingly, Next also revealed that it has had operational difficulties within its Directory division which led to reduced stock availability. The company also highlight that competitors are beginning to match the Directory in terms of its service proposition.

The shares have opened around 3% lower.

Good control of costs means that whilst full price sales growth of 3.7% looks to be heading for a full year outcome slightly below their prior guidance of +4.0% to +6.0%, Next still expects profits to remain within prior guidance of £810m to £845m for the year to end January 2016. The sale has proceeded to plan, with 7% less stock to clear than last year. This guidance excludes an expected £15m profit benefit from the current financial year having an extra, 53rd week.

With the share price having remained above the company's buy-back limit throughout, and cash generation strong, another 60p special dividend is declared, paid on Feb 1 to holders on the register Jan 15.

For the upcoming financial year to Jan 2017, Next are budgeting for sales growth of 1% to 6% with flat margins, leading to profits moving in line with sales. Surplus cash flow for the year is expected to be broadly similar to the £377m seen in the current year.

Our view

Next has been our favoured retail play for the last year or so, and the Xmas trading update is unwelcome news. We can forgive them the impact of bad weather; one might have expected clothes retailers to have an easy time of it this winter, because last year was unseasonably mild. But as it turned out, it has been even warmer this year, making winter coats and woolly jumpers hard to shift.

But the news about specific issues within Directory is more concerning than a temperature-induced sales dip in the stores. Poor stock availability sounds like a euphemism for a warehouse problem, which can be a painful experience for any retailer. But we have yet to see a warehouse problem that could not be fixed, so that is no great concern. More worrying is Next's admission that it is struggling to keep an edge over the competition when it comes to the overall service proposition at Directory.

Roughly half of profits come from the division, and much of Next's famous surplus cash flow comes from the interest earned on the Directory credit book, where customers typically pay over 20% interest on their account balances. Profits have been bolstered in the current year by a change to the credit terms offered, which led to many customers increasing their account balances. The market will be worried that if rivals are becoming more competitive, Next may begin to lose some of these lucrative credit balances.

There is still much to like at Next; we regard it as the best run of the major UK fashion names, and it earns class-leading margins of over 20%. The record on cost control is unparalleled and the group's focus on cash generation over headline growth has been hugely successful.

But so much of the story has been based around the above average growth generated by the Directory division. Take away the current stock availability issues, and Directory's underlying growth is probably rather better than the +2.0% reported for Q4. But it is still likely to be some way below what other retail names are achieving online currently.

The crown has slipped, and with Next still trading at a premium to other fashion names such as M&S or even Debenhams, a degree of profit taking in the stock seems likely.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.