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Next - profit guidance upgraded

Sophie Lund-Yates, Equity Analyst | 28 October 2020 | A A A
Next - profit guidance upgraded

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Next plc Ordinary 10p Shares

Sell: 6,202.00 | Buy: 6,208.00 | Change 98.00 (1.60%)
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Full price sales were better than Next expected in the third quarter. Including interest income from the catalogue business, total revenues 2.8%.

As a result expectations for the full year have been upgraded. Pre-tax profit is expected to be £365m, based on the median scenario - £65m higher than guidance given in September.

However, the group remains mindful of further lockdowns. A two week closure in November across England, Wales and Northern Ireland would result in about £57m of lost sales (6% of quarterly full price sales).

The shares were unmoved following the announcement.

View the latest Next share price and how to deal

Our view

Coronavirus has been a serious headwind for Next. A collapse in store sales of this magnitude would never have been dreamt of in normal times.

However, the group is actually in pretty good shape considering the circumstances. Sales are well ahead of what had been feared and online capacity is back up and running. In fact a strong online performance means overall product sales are back in positive territory. But it's Next's stock management which is particularly impressive - the amount of excess stock that found its way into the end of season sale actually fell year-on-year. That really surprised us, and in a good way.

Retailers are spinning a lot of plates right now, but stock management is arguably the most important. Piles of unsold items can ultimately act as a drag on gross margins and cash flow.

Given the information to hand, we think Next is well equipped to weather the current disruption. Two profit upgrades in a pandemic will do a lot to put most analysts' fears to bed. That means the focus should be on the bigger, longer-term picture.

Next has a stronger online business than many peers thanks in part to its history as a catalogue company. The infrastructure needed to deliver a postal order is, after all, not that different to what's need to deliver an online order. These solid foundation means the group's well placed to capitalise on the longer-term shift to online shopping that's been triggered by coronavirus. Expansion (read: spending) plans means margins could come under pressure, but ultimately we see the long-term shift to online triggered by coronavirus as a growth opportunity. This is especially true of the potential in overseas markets - although this is new territory for the group which increases execution risk.

Next has also done a good job of managing it's store estate. Shops typically have shorter, and more favourable leases than peers. This is a real bonus and gives the group extra flexibility.

We're impressed with the rate of debt reduction too. While sizeable, debt no longer seems over-burdensome.

We're not out of the woods yet though and the introduction of circuit breaker lockdowns closer to Christmas would have an inevitable impact on sales and profits. It's also worth bearing in mind that any economic slowdown would be particularly bad news for the finance business (where Next customers pay using credit). Bad debts are likely to increase, and what is usually a nice extra revenue stream could become a drag on performance.

Ultimately we think a lot of Next's long-term strengths remain in play. But investors should keep in mind ups and downs in the near term are almost guaranteed.

Next key facts

  • Price/Earnings ratio: 17.4
  • 10 year average Price/Earnings ratio: 13.2
  • Prospective dividend yield (next 12 months): 2.3%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third quarter trading details

Sales trends are similar to last quarter, with home and childrenswear outperforming, while formal and occasion wear is weak. Online sales have exceeded last year's levels every week except one since 2 August. Online sales rose 23.1% in the quarter, while store sales were down 17.9%.

Markdown sales fell 12.3%. That reflected lower in store footfall and lower capacity at online warehouses, where full price sales were prioritised. Stores at out-of-town retail parks continue to outperform town centre and shopping centre locations.

Interest income from the Next's credit business declined 13%, because of lower customer balances. That reflects reduced credit sales during lockdown, but there has been a "significant recovery" more recently.

Next's forecasts for the rests of the year assume: further local lockdowns, some customers avoiding shops as they become busier towards Christmas, and warehouse capacity constraints as self-isolation rates increase in peak festive season. The group estimates these outcomes would see full price sales fall 8%.

Under that scenario, full year net debt is expected to fall by £487m to £625m. The cash flow forecast has increased by £25m, which has been held back by £30m of warehouse capital expenditure.

Looking ahead to Brexit, import duties under the UK Global Tariff will increase Next's annual import duty costs by around £13m, instead of savings of £25m it had expected under the temporary tariff arrangement. That could add 0.3% to prices but instead the company says it hopes to renegotiate with suppliers or find new sources, to try and reduce those costs.

Find out more about Next shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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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