Buy into the Next stage

At the heart of the challenges on the high street is the shift to online shopping. The latest data from the British Retail Consortium showed a 1.7 per cent drop in footfall in September.

Next is addressing the change by steadily closing its smaller, less profitable stores in favour of larger, more profitable ones. The group’s most recent annual report laid out potential plans for the next 15 years based on a stress test involving ongoing 10 per cent annual like-for-like declines. This could see store numbers cut to just 270 – 120 would be lossmaking, but would service online sales – while online revenues would be expected to rise sharply. The group’s online operations benefit from a high-street presence, with around half of online orders being collected from stores and many returns also made through shops.

Consolidating its physical stores is helping the retail division’s profitability. Of the eight stores closed in the first half, about a quarter of sales transferred to nearby Next branches. Spreading more sales over an existing cost base means that the closure of modestly profitable stores actually boosts profits overall. Hard-pressed landlords are also desperate not to lose tenants and the level of rent reductions being offered have reduced store closure plans. This has led to a doubling of Next’s expected net store space growth this year to 100,000 square feet. Average first-half rent reduction on lease renewal was 28 per cent. New space is expected to achieve payback in under two years. 

Still, a 4.9 per cent fall in first-half like-for-like retail sales and a drop in net margin from 7.6 per cent to 6.4 per cent meant the division’s operating profit was down 23.5 per cent. Fortunately, the online division did much better, reporting a 13 per cent sales increase that translated into an 8.4 per cent rise in profit after net margin slipped from 18.3 to 17.6 per cent.

The growth of the online business has its own issues. Next’s product range has grown at a far faster rate than sales – unique items grew 141 per cent over the past four years to 592,000, compared with online sales growth of 47 per cent. This has put a strain on the group’s ‘forward locations’ – the locations where individual items are manually sorted – which account for roughly 60 per cent of warehouse space. 

Next is 18 months into a five-year, £310m capital expenditure programme to address this by boosting warehouse and logistics capacity while store investment will fall. Despite the spending commitments, Next is still generating good levels of surplus cash, which continues to fund regular share buybacks – of £305m first-half surplus cash, £280m was spent on shares. Buybacks have been important in keeping earnings per share (EPS) moving forward (by reducing the share count), with a 9 per cent EPS rise expected for the five years to 2020 compared with a 7 per cent profit fall. 

While the group’s net debt has been rising in line with the growth of its credit arm, net debt plus its debt-like rental liabilities have fallen from £2.9bn in 2016 to an expected £2.6bn for the year-end. This represents a comfortable 2.4 times expected ‘Ebitdar’ – a cash profits measure that excludes the impact of rents. 

Next Finance, which allows customers to make purchases on credit, is also showing solid growth following a marked period of account losses in 2015 and 2016, caused by a decision to make it easier to pay by debit and credit card as it moved its catalogue business online. First-half interest income rose 9 per cent to £134m, while bad debt charges dropped 26 per cent to £19m.