Next target slashed by doubter

Battling against unseasonable weather, sector-wide discounting and a poor website, it's been no easy ride for Next. As if profit warnings weren't enough, chief executive Simon Wolfson said market conditions are "the worst since 2008". Fearing sales cannibalisation, broker Berenberg has downgraded Next shares and taken an axe to its price target.

Trading sideways in a bearish trading channel since early October, the negative trend had established itself by March with the shares losing 40% of their value and slipping below 5,000p early May. After a 4% rise Monday, they're back at around 5,500p again, a level with some magnetism over the past few months.

But investors shouldn't become too complacent: Berenberg has just slashed its target on Next shares from 7,300p to 4,800p.

To be fair on Next, its new mobile-friendly website should help grab customers, with normalising weather mitigating some of the temporary headwinds that have recently dampened the retailer's share price.

Unfortunately this does not deal with the changing face of Next's customer base, which analyst Michelle Wilson thinks will pose a significant challenge in the long term.

Shifting away from higher-spending and more profitable account holders, the dominance of less loyal cash customers is pulling on revenue and profitability. While account holders spend around £476 a year, £404 of which is from products, cash customers spend half of that at £210.

"The near-term negative impact of a decline in the number of account customers has been offset by the rising debts of the account customers that remain. Our concern is that this trend is unsustainable. As a result, Next may face further revenue pressure and an increase in bad debts."

With like-for-like sales falling each year for the last five, bar one, and over half of Next Directory orders collected from the store, Wilson is certain growth of directory is cannibalising retail revenue and squeezing margins. Management have opened bigger stores, are offering click-and-collect and are charging for home delivery to try and offset this, but Wilson reckons better capital use is needed, along with further store closures in favour of free home delivery.

"We believe UK Directory growth will remain challenging for Next as management continues to protect margins. Offering free home delivery would be painful in the short term, diluting Directory [operating profit] margin by about 4 percentage points, but it is essential to adapt to changing consumer demands in our view."

Prioritising profitability over market share, weaker revenue expectation has already triggered a downgrade in earnings per share (EPS) forecasts of 6%/5%/5% in 2017/18/19.

Now, the analyst is expecting EPS of 439.5p, 456.9p and 474.9p respectively. Management hasn't wavered from its £350 million cash guidance, but this will likely be spent on share buybacks instead of dividends, says Wilson.

The team of analysts aren't completely against the retailer, acknowledging its high profitability, its flexible and cheap store portfolio and history of capital discipline and returns.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.