Diversified retailer Next PLC (LSE:NXT, Financial) traces its beginnings back to the 19th-century city of Leeds. This company is, however, probably the most modern and well managed UK retailer, with a market capitalization above perhaps better-known brands such as Marks & Spencer (LSE:MKS, Financial) or Asos (LSE:ASC, Financial).
The company has upgraded its profit guidance for the fourth time this year at September’s half-year results, and the stock price is trading near an all-time high as a result..
Lord Wolfson of Aspley Guise, its chief executive, has built a deserved strong reputation for operational excellence and says “execution is 90% of the battle.” His habit of conservative forecasting and attention to detail gives me great confidence in the company. The company now expects pre-tax profits of 800 million British pounds ($1.1 billion) this year - that’s nearly 7% above where they were in 2019.
Unlike many rivals, Next isn’t a pure play physical or online business. In fact, its edge over its rivals has been in creating profitable and efficient synergy between online and in-store. Channels for online revenue growth have been broadened and Next’s own-brand revenues rose by 46% in the H1 results.
Next’s e-commerce offering is also attractive for third-party brands, for which it earns a percentage of sales. Brands saw faster sales growth of 70% during the first half as new labels were introduced and the products mix from existing brands was increased.
Then there is Next’s Total Platform, which is a system for third parties to turbocharge the development of their online businesses. Six companies, including Gap and Victoria’s Secret UK, have signed on to use Next’s technology, warehousing and logistics infrastructure.
Click-and-collect is getting more popular, although the decline in store sales is unlikely to reverse and Next’s management is factoring this trend into their outlook. In the three years before the pandemic, store sales were falling by about 6% on a like-for-like basis. Even after adjusting for the estimated sales lost through lockdowns, the retail segment’s margin for the first half was around 6%, compared with 10% in 2019.
Next is making progress on reducing its shop rent costs, and this should help offset headwinds from declining store sales. Management says the rent expense for the 73 leases scheduled for renewal this year is expected to halve. Also, with about a third of those leases being on revenue-linked rents, this insulates against some of the downside risk. Wolfson wants to see an increase in the percentage of leases on revenue-linked rents, to share the risk with landlords.
As more store leases come up for renewal over the coming years, Next’s strong performance against a backdrop of post-pandemic retail failures should put it in an even stronger bargaining position with landlords as it is seen as a blue-chip tenant.
Next is realistic about its online growth going forward. Full-price online revenue growth is expected to slow slightly and be up 32% for the full year, compared with 44% for the first half. But the impressive fact is that pre-pandemic online revenues and profits managed to counter in-store declines, and this gives me great confidence in the longevity of earnings performance.
Risks
Next obviously has some challenges. Current supply chain disruptions have seen inventory levels drop 12% compared to two years ago, and even by December, these are still expected to be 5% below 2019 levels. An obvious question is, will customers be satisfied with alternative items?
Then there’s also the challenge of higher freight costs and wage inflation potentially hurting margins. Next has already increased prices by 2% and plans to increase prices again by another 2.5% in the first half of next year to try to protect margins. But these issues are short term in my view, and Next’s management will no doubt jump these hurdles relatively easily.
The company has secured funding to see through on its plans to increase warehouse capacity. Capital expenditure for warehousing and technology is set to total ÂŁ152 million this year, and it looks like the company has plenty of headroom with its ÂŁ1.25 billion debt facility. With its Altman Z-Score of 4.6, Next sits firmly in the quality category for me.
At present, most of the company's offerings consist of its own Next-branded products, but with a price-earnings ratio of 18, the stock isn’t pricing in the growth potential of its Total Platform business, which holds the prospect of a return to long term growth for the group.
Next is slowly turning into a platform business in addition to a retailer. That makes it a very interesting prospect. The CEO writes in detail about the company in each annual and half year report, which makes the stock worth following for this reason alone. In 2019’s annual report, for example, his "Fifteen Year Retail Stress Test" was a masterpiece in retail scenario analysis, and well worth reading even for those who have no plans to invest in the stock.
