January Blues

Next's Unfair Punishment

Times are tough in clothing, but this equity pounding looks harsh.

Next Plc has delivered the first disappointment of the post-Christmas retail sales reports.

That's a worry: it's usually one of the winners. If life is difficult for Next, then it's going to be even more so for other clothing store groups reporting next week, including Marks & Spencer Group Plc and Debenhams Plc. And what's more, conditions are set to get tougher still in 2017. But that doesn't mean Next deserves the punishment it's getting in the stock market on Wednesday. 

Sales from Nov. 1 to Dec. 24 missed estimates by some margin: branded full-price sales fell 0.4 percent, the company said, compared with the consensus of analysts' estimates for a 2.2 percent increase. This is partly down to a broader trend by shoppers to purchase less clothing, and in addition, this holiday season more people stayed away from physical stores.

Next Stores Up Trouble

Sales at physical stores were a particular weak spot in the run up to Christmas

Source: Company report, Bloomberg Intelligence

Consequently, Next expects pre-tax profit in the current fiscal year to be toward the lower end of its estimates, and to be even less in the year after. 

There are some company-specific issues here: Like rival M&S, it's a mature business that generates a significant proportion of its sales from clothing and footwear -- about 80 percent in Next's case. Chief Executive Officer Simon Wolfson says this sector is experiencing near-recessionary conditions.

Next is also under pressure from rivals that are getting their act together when it comes to internet sales, eroding the advantage it enjoyed for many years. Efforts to improve its online Directory arm further, such as more personalization, appear to be paying off: sales at the unit rose 5.1 percent in the period, compared with a flat performance in the third quarter. But that's coming with a cost -- Next will invest 10 million pounds ($12.3 million) in the coming year to improve its website and online marketing.

But there are other factors at play here too that are industry wide. And Next is better positioned than most to battle the coming challenges.

Although clothing and footwear sales improved in the fourth quarter compared with the third, this was not enough to convince Wolfson that demand would revive in 2017. The slump in sterling should raise import costs, and means clothing prices may increase by up to 5 percent, potentially dragging down sales volumes. And a broader pickup in inflation will squeeze consumer spending power too.

Those same factors are going to affect other retailers with clothing businesses, particularly M&S.

Next's fourth-quarter report pushed shares down 10.1 percent, and they now trade on a forward price earnings ratio of 9.8 times, a discount to M&S's 11.2 times and 13 times for the broader FTSE 350 General Retailers index. 

Pretty Harsh

Next's share-price drop on Wednesday looks overdone, compared with the rest of the FTSE 350 General Retailers index, given its strong cash flow and skilled management

Source: Bloomberg

That looks harsh. Next is facing up to its challenges: it's investing in Directory, and has long managed its store estate effectively. If a further adjustment is needed after sales at physical stores were particularly weak, it will likely take this action. That's a sharp contrast to M&S, which, as Gadfly has argued, has been slow to tackle its excessive property holdings.

It also continues to be highly cash generative, forecasting free cashflow of 340 million pounds in the current fiscal year and between 255 million and 345 million pounds in the "challenging" year to follow. It will continue to return surplus cash to shareholders.

Wolfson has a habit of under-promising and over-delivering, although he didn't manage this feat in 2016. Of course it's possible the usual pattern could resume this year. 

But even if he sticks with his pessimistic forecasts, in a tumultuous retail environment, Next still looks a relatively safe haven.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andrea Felsted in London at afelsted@bloomberg.net

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

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