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Next - Retail continues to struggle, but Directory improves

George Salmon | 15 September 2016 | A A A
Next - Retail continues to struggle, but Directory improves

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Next plc Ordinary 10p Shares

Sell: 6,380.00 | Buy: 6,384.00 | Change -16.00 (-0.25%)
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Shares in Next fell by 2.5% this morning after the group released half year results.

Total group sales are up 2.6% for the period to £1,957m, with Directory again outperforming Retail. Despite a 1.5% drop in profit before tax, Next's £176m of share buybacks ensured that earnings per share rose by 0.8%.

Retail sales were up 0.1% to £1,084m. However, with new space contributing 2.8% to sales growth, like-for-like sales continue to decline. Retail operating profit fell by 16.8% to £134m, as net operating margin fell from 14.9% to 12.4%, with markdowns making up a greater percentage of sales.

Despite the current difficult conditions, Next plans to increase sales space, with square footage set to hit 8m by the end of the year, an increase to 4.5%.

Directory sales grew by 7.1% to £821m. As margins ticked up by 0.9ppts to 24.9%, operating profit has increased by 10.9% to £204m. Next are making headway with some of the measures unveiled in March aimed at improving Directory's performance amid the rising competition. Stock availability and the mobile site have both improved, and the new online marketing campaign is seeing positive initial returns.

Next has declared ordinary interim dividend of 53p per share, in line with last year, with another £30m of buybacks expected this year.

Next's net debt is set to finish the year at around £859m, £120m higher than originally forecast. However, Next comfortably retains an investment grade rating and the money owed to the group via the Directory debtor book is now £953m.

On current trading, Next say that sales in July did bounce, but this can be attributed to a much larger end of season sale. Trading since July as remained challenging and volatile, so Next's full year guidance remains unchanged. NEXT Brand full price sales growth is expected to be between -2.5% and +2.5%, with earnings per share between -2.5% to +6.3%.

Our view:

After a particularly disappointing start to the year, performance has improved but Next clearly do not believe that they are out of the woods just yet.

Unseasonal weather has impacted sales across the sector, and Next has had issues with stock availability within Directory. These factors are, we feel, part and parcel of the retail game. More of a worry is CEO Lord Wolfson's wider concerns that that we could be seeing an underlying fall in demand for clothing. Although the market seems to be less concerned about any negative impact on the UK consumer as a result of Brexit, the vote to leave has caused the pound to drop dramatically. In all likelihood this will make imported textiles more expensive, which could lead to the return of a nasty foe: inflation. Next forecast that they can limit increases to 5%.

Further to this potential headwinds, Next has woken up to the realisation that it cannot necessarily count on Directory to deliver consistently the sales growth it has done previously. Retail moves fast, and it seems that the group's next day delivery service no longer sets it apart. Competition is coming from all angles, with online-only players like Boohoo and ASOS taking market share, while traditional retailers like Debenhams have significantly raised their game over recent years.

Next's response, which includes measures to improve the mobile app and modernise their online proposition, has delivered a positive response so far, but it remains early days. With Directory now contributing more to profits before tax than Retail, it is likely that the group's success or otherwise in adapting to this challenge will likely dominate the narrative for the foreseeable future.

Operationally, we still view Next as a very well-run business. 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. This time last year the shares were trading on a price to earnings ratio (P/E) of close to 17x. Nowadays the shares trade hands for a touch under 12x, which is a very sharp de-rating for such a high quality, cash generative business. However, Next is clearly finding life tougher and the outlook for the business is more uncertain than it has been for some time.

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.

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