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Next - Conditions remain challenging

George Salmon | 23 March 2017 | A A A
Next - Conditions remain challenging

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Next plc Ordinary 10p Shares

Sell: 5,966.00 | Buy: 5,972.00 | Change 124.00 (2.12%)
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Total group sales dipped 0.3% to £4.1bn, with revenue growth of 4.2% in Directory offsetting a 2.9% decline in Next Retail sales. While the group remains cautious on the future, previous guidance is left unchanged. The full year dividend is held flat at 158p. The shares rose 5.6% on the news.

Our View

After starting last year at over £70, Next shares now change hands for under £43. While it's true that industry-wide headwinds have hampered the sector generally, Next has plenty of its own issues to contend with.

The vote to leave the EU caused the pound to drop dramatically, which is bad news for most UK retailers as it makes imported textiles more expensive. To combat this, Next is raising prices by up to 5%.

While the alternative (holding prices steady and taking the hit on margin) is probably less palatable, this increase could put off shoppers in such a competitive sector, particularly as inflation has started putting the squeeze on disposable incomes. CEO Lord Wolfson also has long-standing concerns that consumers are shifting spending away from clothing and towards casual dining and entertainment.

In addition to these factors, Next's Directory (online and catalogue) division is struggling to deliver the double-digit sales growth of times gone by. Competition is coming from all directions, with online-only players like Boohoo and ASOS taking market share, and other more traditional retailers significantly raising their game.

Steps are being taken to improve the mobile app and modernise the online proposition, but it remains early days. Directory contributes more to profits than the high street Retail division, so rectifying the problems here is crucial for the group.

Next has historically been very well run. It still earns class-leading margins of over 20%, which helps it generate significant surplus cash. In the past, Next has used this cash to buy back its own shares when the price fell below a set level, arguing that it represented better value for shareholders than paying special dividends. This makes the move to focus on specials this year, despite the share price fall, an interesting one.

The shares are trading at a shade under 10 times forecast earnings, below many of its peers in the sector, and almost 20% below its own long-run average.

Full year results:

Despite improved margins in the Directory business, declining sales and greater markdowns in the Retail division led group margins to dip from 20.7% to 20.2%. With revenues flat, group operating profit fell 2.8% to £828m. This includes £339m from Retail (down 15.8%) and £444m from Directory (up 9.6%).

In the Retail division, the group closed 29 stores during the period, but the 27 that were opened had the effect of increasing sales space by 330,000 sq. ft., or 4.3%. Next says it will add 150,000 net sq ft in 2017 and a further 250,000 sq ft in 2018, at rents significantly below its current rates. Central guidance is for like-for-like sales in the Retail division to fall by 7% next year, with operating margins falling from the current 14.7% to around 12%.

Next's Directory customer base increased from 4.55m to 4.73m, with continued decline in UK credit account customer numbers more than offset by growth in cash customers in the UK and more overseas customers. Within Directory, the International and the UK LABEL businesses continue to perform well, with sales rising 19% and 14% respectively.

The group remains extremely cautious about the sales outlook for the year ahead. As per the guidance issued with January's trading update, Next expects total full price sales growth for 2017/18 to be between -3.5% and +2.5%, with earnings per share growth of between -12.4% and +0.5%.

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.