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Next - sales worse than expected

Sophie Lund-Yates, Equity Analyst | 29 April 2020 | A A A
Next - sales worse than expected

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Next plc Ordinary 10p Shares

Sell: 4,853.00 | Buy: 4,863.00 | Change -218.00 (-4.29%)
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Sales have fallen faster than stress tests completed in March suggested, and Next is now modelling lower sales for the remainder of the year. It also believes the effects of coronavirus will be felt for longer than first thought.

The group is looking to achieve higher cost savings and stock cancellations, including suspending the buyback and dividends. On current expectations net debt will be lower at the end of the year compared to last year even in the worst case scenario - which would see sales fall 40%.

In the event that sales fall 35%, full year profit will be £0.

The shares were broadly flat 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 dealing with the closure of all its stores and a much thinner online operation.

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, historically, Next has been 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. The online business had been growing rapidly as a result, helped further by third party sales. Around half of online sales completed through click & collect, and over 80% of returns were 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.

These bright spots are being dulled by the current store closures and limited operating of the online business. Stress tests suggest it has some breathing room when it comes to a loss of sales, but even the best run retailer would find a prolonged shut down challenging.

It's planning to weather the storm with daunting and expensive cost saving measures, which will be crucial to how it fares over the coming months. We also wonder what all the excess stock will mean. There are so many extra items the group's drafted in extra storage. Trading is going to be subdued long after lockdowns are lifted, so shifting all this summer's T shirts won't be an easy ask - even when they're chucked on the clearance racks.

The ensuing economic slowdown isn't great news for the finance business either. Bad debts are likely to increase, and what is usually a nice extra revenue stream is likely to flow more slowly as fewer people will pay their interest.

The balance sheet isn't in terrible health, but there is a meaningful debt pile. If trading's shut down for longer than expected and cash flow takes a hit, it will be harder to service interest payments on debt.

Overall the stress tests suggest Next should weather the coronavirus storm, but at this early stage no one can say for certain what the business will look like at the end of it.

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COVID-19 trading details

Total full price sales fell 38% in the period 26 January - 25 April. Within that retail sales were down 52% and online fell 32%. In the three days before stores were closed on 23 March, sales were down 86%.

Warehouses reopened on 14 April, allowing the online store to reopen. The ramp up is slow to ensure social distancing, with only a certain amount of orders allowed per day. Capacity is expected to be 70% of normal levels by mid-May.

Finance interest income from the credit business rose 2%. However, Next will reduce lending to customers by £300m this year, and defaults are expected to increase.

The group is planning to adapt stores to ensure they can accommodate social distancing when they reopen. As a result larger, out of town shops will be reopened first. It anticipates it will take some time for customers to return to normal shopping habits and sales will be very subdued when trading recommences.

Excess stock is being stored in new additional storage facilities. The amount of clearance inventory is expected to be 15-45% higher than last year. In each scenario Next is assuming the loss of £50m of clearance sales. Stock for later in the year is still being ordered to accommodate the different season. £290m has been saved by stock cancellations, after compensation payments to suppliers.

Cost savings will come from areas including non-wage operating costs (£120m saving), lower wages (£135m saving) and business rate and corporation tax (£250m saving).

Net debt and financing update

Net debt will have peaked in February at £1.15bn, and has now fallen as a result of the sale of Employee Share Ownership Trust shares for £86m, and proceeds from the sale and leaseback of a warehouse will see this fall further. In the case of a 35% drop in sales, full year net debt will be £740m.

Next's lenders have agreed to temporarily waive financial conditions attached to the revolving credit facility, known as covenants. The group also confirmed it's eligible to borrow through the government's Covid Corporate Financing Facility, but thinks it "unlikely" it will need to use these funds. Overall Next has access to £1.6bn in bonds and bank facilities.

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