Style and Substance

Next's Island of Stability

Clothing retailer has performance levers to pull as inflation bites.
As of 5:52 AM EDT
5184.00 GBp

You wouldn't know it from the official retail sales data, but the British consumer is pausing for breath.

Simon Wolfson, chief executive officer of Next Plc, alarmed the market in January when he warned on this year's profit after a disappointing Christmas. Trading conditions since then confirm Next was right to be cautious, he said on Thursday, as he reported the company's first earnings drop in eight years. 

Next was early among retailers to warn of the potential dangers to the consumer after the Brexit vote, and it was punished accordingly, with its shares falling as much as 42 percent from a year ago. Thursday's Office for National Statistics figures showing stronger-than-expected retail sales in February suggest Wolfson may be even more of an outlier. But he has a track record of correctly forecasting the direction of the British consumer, so ignore him at your peril.

Profit Pause

Next's annual pre-tax profit has fallen for the first time in eight years

Source: Bloomberg

A combination of incomes being squeezed by higher inflation, as well as an element of "sticker shock" as price increases hit the shops, are causing consumers to think twice about spending -- you only have to walk down the high street to see the sea of red "sale" banners.

And the prospect of inflation outstripping wage growth does not bode well for sales of big ticket items such as TVs, or discretionary items such as clothing, which has the added strain of being out of fashion anyway.

So while the ONS's monthly data show a picture of stellar spending, the three-month picture is darker. Kallum Pickering, an economist at Berenberg Bank in London, is among analysts forecasting a contraction in retail sales in the first quarter. 

Out of Fashion

Clothing has mostly lagged as consumers spend their money elswhere

Source: U.K. Office for National Statistics

So some caution on all British retailers is warranted. But Wolfson's report today confirms what Gadfly has argued, that Next is better placed than most to survive the coming storm. 

Indeed, there were some crumbs of comfort in Next's commentary. For one, it didn't cut its outlook for this financial year any further.

It also said that prices for clothes going into stores now are 4 percent higher, in line with its earlier forecast for an escalation of less than 5 percent. And weak factory orders have created a buyers' market for retailers that may limit price increases in the second half. This could ease some of the strain from higher sourcing costs as favorable sterling hedges expire.

Furthermore, Next is highly cash generative. At the mid-point of its sale and profit guidance, it expects to generate surplus cash of 300 million pounds ($375.3 million) after capital expenditure and paying ordinary dividends. It's also returning cash to shareholders, with a forward yield of 8 percent, including special dividends.

Past Premium

Next has lost its superior rating to M&S as sales and profit have suffered

Source: Bloomberg Intelligence

And Next has some levers it can pull to help its performance. Its work to make its styles more appealing will take time to pay off, but should help defend sales in a difficult environment. Its investment in its Directory business looks like it's already working.

Store leases are, unusually, not really a millstone around its neck -- it revealed that about half will expire within the next six years, so it can close or move locations as needed without resorting to an expensive overhaul. That's in stark contrast to Marks & Spencer Group Plc, which will close up to 60 clothing outlets at a cost of up to 350 million pounds.

Investors liked what they heard from Wolfson, at one point lifting the shares the most in three years. Next trades on a forward price earnings ratio of 10.3 times, a discount to M&S's 11.6 times.

That rating looks harsh. Next offers some rare stability in a year that's set to be a wild ride for U.K. retailers. 

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

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