From many angles, Next is a triumph. Under Simon Wolfson's leadership since 2001, the company has delivered an impressive chapter of outperformance. As of a year ago, it had over the previous five years delivered about twice the return of rival retailers. The picture has dimmed since then, but most think the company is still in good shape. Last week, JP Morgan trimmed its forecast for Next and predicted negative like-for-like sales until 2010. Nonetheless, it said Next is a "well managed retailer that has a plan for tough times".
Mr Wolfson has rejuvenated the Next brand through a myriad of operational initiatives which are well described in the company's annual reports - these are in my view a model of good reporting. But the company's impressive earnings per share (EPS) performance has also been underwritten by a huge share buy-back programme, which cost over £500m last year at an average price of £19.74 - approximately twice the current price. Since Mr Wolfson took over, Next has repurchased approaching half the shares it had in issue as of 2001, and the programme is continuing, with the most recently reported purchase made just a week ago at £13.35 a share.
Finances still look fine
With views coloured by the current generalised share-price slowdown, many shareholders will ask themselves whether these purchases really make sense. They will only know in the long term. As I said last week, share repurchase decisions may look poor in the short term, but should be beneficial when trading returns to normal if they do not denude the company's balance sheet. There is no indication that the repurchases have left Next undercapitalised. Last year, its interest cost was more than 10 times covered by trading profits. All borrowings are in the form of 10-year fixed-rate bonds. Even if rents are lumped into the income gearing calculation, it remains pretty comfortable at about two-and-a-half times.
Look who really benefits
But there is one constituency to which the share purchases make eminent and immediate sense. Next's annual bonus arrangements for its directors are a model of transparency - they are based on the single measure of EPS before tax. A minimum bonus is paid if EPS before tax grows by 5 per cent, and the full bonus of 100 per cent of salary is paid if EPS grows by 20 per cent.
Over the past three years, these arrangements resulted in annual bonuses of 56 per cent, 78 per cent and 31 per cent of basic pay for executive directors. I should say that I do not consider these numbers to be objectionable when compared with payouts at other companies. Nor, indeed, are the basic salary levels, which range from £325,000 a year up to £605,000 in the case of Simon Wolfson. Many less deserving cases pay themselves far more generously.
But they are open to the accusation that they rest heavily upon the share buy-back programme. What should directors be paid for? Should they be paid for good like-for-like sales, successful acquisitions, investments to bring on successful new businesses? …in other words, for "the business of business"? Or should they be paid for moving money from account A to account B, which is in effect what a share buy-back is.
Last year, Next's directors were certainly paid for moving money from account A to account B. And they made very few bones about it: as Simon Wolfson said in the opening sentence of his chief executive's statement: "In the year ending January 2008, Next increased operating profits by 5.8 per cent in a worsening environment… Earnings per share moved forward [by 15.5 per cent] as a result of share buybacks and a lower tax rate." I have not worked out the effect of the lower tax rate, but it looks pretty modest to me: it fell from 30.5 per cent to 29 per cent.
Some might feel that Next's directors deserved generous bonuses for the 5.8 per cent improvement in operating profits. But few would argue that the formula adopted by Next's remuneration committee does not principally reflect the transfer of money from account A to account B. In a perfect world, remuneration committees would ignore the effect of share buy-backs when devising incentive schemes.
