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Next - profit up, conducts COVID-19 stress tests

Sophie Lund-Yates, Equity Analyst | 19 March 2020 | A A A
Next - profit up, conducts COVID-19 stress tests

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Next plc Ordinary 10p Shares

Sell: 6,000.00 | Buy: 6,004.00 | Change 104.00 (1.77%)
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Full year group sales rose 3.3% to £4.4bn, reflecting a strong increase in the online business. Operating profit rose 1.3% to £772.1m.

The group conducted stress tests in the wake of COVID-19. The findings showed the group could sustain the loss of more than £1bn (25%) of annual full price sales. This scenario could require cash saving measures including some or all of: deferring or suspending the dividend, halting the buyback and non-essential capital expenditure.

The uncertainty means Next expects to propose a second interim dividend in June, rather than a final dividend.

The shares rose 6.6% following the announcement.

View the latest Next share price and how to deal

Our view

"People do not buy a new outfit to stay at home." CEO Simon Wolfson has a very good point. The coronavirus poses an unprecedented challenge for retailers, and Next is preparing to deal with a significant drop in sales, both online and in store.

That's an added problem in an already tough market. Next's in-store sales have been going backwards for some time as the high street grapples with falling footfall and a shift to online.

But we actually think Next is ahead of the pack.

The group's been able to capitalise on the shift to online shopping, thanks to its history as a catalogue company. Distribution infrastructure was already in place, and could be fired up quickly when e-commerce came knocking. The online business continues to grow rapidly as a result and these days it sells third party brands on the site too, which boosts sales further.

Interestingly, around half of online sales complete through click & collect, and over 80% of returns are made in store. That means Next still sees a place for bricks and mortar, and is behind its strategy to keep opening new shops.

New leases are typically short, providing extra flexibility. So far the group's proven adept at securing favourable terms from landlords, but there's no guarantee this will continue.

Next needs to make sure it strikes the right balance between opening new space to support growth though, and not having too many shops. Too much space could be a problem if conditions on the high street get materially worse.

Something that sets Next apart from some of its neighbours, is its finance business - offering people the option to buy today and pay tomorrow. Interest income is growing steadily, providing an extra revenue stream.

The shareholder returns policy also strikes us as sensible. It seeks to allocate surplus cash flexibly and efficiently. This means buying back its own stock when management believe it worthwhile, and paying special dividends when the price is judged to be too high for buybacks. For now the decision to delay a decision on final dividends seems sensible to us, and as the pandemic progresses we wouldn't be surprised if "pause" is pressed on the buyback. The group repurchased £300m of shares last year.

Overall we still think Next is doing well in a tough sector. The group's stress tests suggest it could weather the coronavirus storm, but at this early stage no one can say for certain what the outcome will be.

The shares trade on 8.1 times expected earnings, significantly below their long-term average.

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Full Year Results

Total Retail sales declined 5.3% to £1.9bn. That reflects a 4.3% fall in full price sales- although this was ahead of previous expectations. The sales beat was driven by better stock availability and improved delivery processes.

Operating profit fell 22.8% to £163.9m. Net margins declined 2 percentage points to 8.9% due to the costs of store occupancy and other fixed costs. These increased as a percentage of sales because of falling like-for-like sales.

Next renewed 44 leases, with rent on these stores coming down by 30% and the average lease length on these stores is 3.6 years. Net new space grew 1.2%, and is expected to fall 0.8% next year.

Total Online sales rose 11.9% to £2.1bn, while operating profit improved 13% to £399.6m. Cost savings saw net margins improve slightly to 18.6%. NEXT brand still contributes the majority of divisional profit, accounting for 62%.

Online customers collect nearly 50% of their orders from a store, and over 80% of returns.

Next is working on new platform for its third party sellers and has agreed terms to build and operate their website for them. "The website would look and feel like the client's website but would be built on all the functionality available on NEXT's own website". This setup is going live with one client later this year.

Next's Finance business contributed £146.7m to group profit, finishing the year with £1.2bn of outstanding consumer debt. Bad debt fell 16.9% to £43.3m.

After dividends the group generated cash of £307m. Underlying net debt was broadly flat at £1.1bn.

The group said uncertainty around coronavirus makes it impossible to give meaningful guidance for the year ahead.

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