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Next - profit warning ahoy #2

By Chris Bailey of Financial Orbit | Thursday 4 May 2017

Disclosure: I own shares in one or more of the stocks mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Back on the 4 January I observed in the hours after middle-of-the-road clothing retailer Next (NXT) had issued a profits woopsie that:

‘Next will survive and with the shares today trading at x10 EV/ebit using the January 2018 published numbers from the company it is getting cheap. From here I think you will make money on it during the balance of 2017 but heed the update’s general message: consumer stocks without great product and/or with exposed balance sheets are at risk of being Scrooged.’

Well the seasons may have evolved a little but the message from the FTSE-100 clothing behemoth is basically unchanged. Life is still tough in a market where in its words ‘the UK consumer environment remains challenging’.

I should coco with real wage growth the square root of nothing and retail competition levels inflated courtesy of the internet and ‘fast fashion’ operators, especially as Next doesn’t believe its current product range will be ‘where they wanted them’ until the Autumn. Next Directory sales managed to push up 3.3% in the first quarter, but the core High Street retail arm saw full price sales down a cool 8.1% - no wonder the full price sales guidance for the year to January 2018 has been reduced from an already shabby +2.5% to -3.5% to a decidedly desultory +0.5% to -3.5%.

Sales as always in retail are just for vanity – and we must look for some valuation sanity towards earnings (and cash flow remains gospel). On this middle metric the news was even worse: an expected year-on-year profit contraction range of -1.3% to -13.9% has now morphed to a best case fall of just an anticipated profits fall of -6.4%.  At least they did not slash n burn the lower band of the guidance. Bottom line you should regard it as a profit downgrade of c. 5%...around about the same proportional amount that the share is down today. 

So life is tough…but tell me something we do not already know to some extent. January’s guidance puke pushed the shares down to the c. £40 level and it is noteworthy that today’s update has not breached this level. In short, the market is well aware of these challenges and is valuing the shares – currently trading around a x10 EV/ebit multiple with a 5% headline dividend yield and share buybacks on top of this – already lowly.

This level remains the key support point for the shares and I still take the view that investors who buy at/around it will be rewarded by the end of the year and beyond. Next’s strong balance sheet and shareholder remuneration backed by cash flow generation helps materially and the cherry on top of the cake may be those superior product ranges…I guess they may discover a new, stunning shade of beige to sell us clothes in!

Next is a survivor and as it is out of favour with strong cash flow I think you can make money on it. But I repeat my warning from the start of the year: the competitive retail environment is taking no prisoners and given elongated consumer debt levels this backdrop is not going to change any time soon. Make sure any exposed names you own or are considering purchasing are either market leaders or have great balance sheets or cash flow generation characteristics…or face the consequences.

Chris Bailey is the editor of Financial Orbit

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