Light Years Ahead

Retail Fireworks Are So Distracting

Next is the safer option even if it lost the Christmas battle.

Its been a season of U.K. retail surprises so far, with unexpectedly positive news from grocers Wm Morrison Supermarkets Plc and J Sainsbury Plc.

Thursday brings the holiday results from Marks and Spencer Group Plc, and signs of a Christmas triumph may be taken as a signal that the troubled child of the British clothing market is about to swap places with its golden boy, Next Plc. But investors should take care not to get caught up in these short-term fireworks.

M&S may report flat same-store clothing and home furnishing sales, according to the Bloomberg consensus, although company broker Morgan Stanley expects a 1.5 percent increase. If it's right, that would be only the second positive quarter in almost six years. The absence of pre-Christmas sales should also help the gross margin. 

High Streets Ahead

M&S's forward p/e ratio pulled in front of Next's on recovery hopes

Source: Bloomberg

Either would be a stark contrast to Next Plc, which reported worse-than-expected holiday results last week and warned conditions would remain tricky in 2017. That's an unwelcome about-turn from a company that's consistently reported profit growth.

In some ways, Next and M&S face similar problems. Both are mature businesses, with aging customers, exposed to the troubled clothing market. They're also facing more competition, including from Sainsbury, which said Wednesday its clothing sales rose 10 percent in its third quarter.

So Thursday's report might appear as part of a story of M&S triumphing over tough conditions and leaving Next in the dust. But make no mistake. Look through all the fluff of the earnings reporting season, and the real story is that Next is still light years ahead of M&S, in terms of its store estate and profitability.

To start with, M&S's report will be flattered by last year's 5.8 percent drop in same-store sales of clothing and home furnishings, and five extra days of post-Christmas trading.

Although M&S's food growth has been fading recently, it kept the company afloat through many lean quarters for clothing, and Chief Executive Officer Steve Rowe's expanding the division. Next doesn't have this option.

Recovery Potential

Same store sales growth in clothing would be welcome at M&S as food is fading

Source: Bloomberg

December 2016 is the consensus of analysts' forecasts

This isn't an easy win for M&S. Margins are lower at its food arm, and it operates at the premium end of the market. Consumers might just put one less ready meal or indulgent dessert in their baskets if food prices rise.

What's more, the company faces significant restructuring costs as it prepares to exit part of its international business and close some domestic stores. Next's store holdings are in good shape, so it doesn't face these costs, though it is investing 10 million pounds ($12.1 million) in its online division to meet competition from nimble rivals.

Rowe is doing many of the right things at M&S, and at least he hasn't announced another big capital investment plan, which is a relief to shareholders who'd endured the previous big-spending CEO. But the company's still in recovery mode and it will take time for his plans to deliver.

While there's a danger that Next's sales will deteriorate further, it's more likely that it will be the steadier ship in the difficult clothing market. It's being proactive on internet competition, and the already-prudent management of its store estate means it faces less of a fundamental overhaul than M&S. 

High Bar

Even with Next's gloomy outlook, pre-tax profit is forecast to beat M&S over the next two years

Source: Bloomberg, Company Reports

Next 2018 is low end of company's estimate

Next CEO Simon Wolfson is also continuing to return cash to shareholders, while M&S has halted its capital return. Assuming an unchanged total dividend of 158 pence, and special dividends of 180 pence, Next has a prospective dividend yield of 8 percent, compared with 5.5 percent at M&S.

The stock market still seems to have come out in favor of Rowe. Shares in M&S are down 19 percent over the past year, but Next is down 39 percent. M&S trades on a forward price earnings ratio of 11.9 times, compared with 10.1 times for Next. 

If M&S does indeed surprise on the upside on Thursday, the gap between the two might well expand further. That wouldn't be justified by the fundamentals. As fashionistas know, some trends are notoriously fickle. 

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

    To contact the editor responsible for this story:
    Jennifer Ryan at

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