Next promises dividend windfall as shares crash

If investors required confirmation that retailers are in trouble, high street fashion chain Next has just provided it, in spades. Fourth-quarter sales couldn't even beat a "poor" period the year before, and we're warned that profits will fall, and keep falling. Even a promise of quarterly special dividends has failed to prevent a share price plunge of as much as 14%.

Next chiefs had expected full price sales to grow in the 54 days up to Christmas Eve, and consensus in the City was for a 2.2% increase. Instead, they were 0.4% lower than in 2015 when the firm blamed a "disappointing" 0.5% decline on "unusually warm weather". Sales for the year so far are down 1.1%.

Directory sales rose 5.1%, true, but Next retail sales for the period were down 3.5% versus forecasts for a 0.5% improvement, which implies a like-for-like drop of 5-6%, according to Investec Securities.

Worryingly, there were declines across the board, even at the popular Home business.

We're also told that, while there was less stock for the end-of-season sale, revenue was down 7% which will cost the company £3 million. Once everything's been through the wash, Next now believes it will make only £792 million in the year to January 2017, give or take £7 million. It had previously pencilled in £785-£825 million. We'll get confirmation on 23 March.

'We expect the cyclical slow-down in spending on clothing and footwear to continue'And the next 12 months could be even worse, admits chief executive Lord Wolfson, who warned us in March that 2016 could be the "toughest since 2008".

"The fact that sales continued to decline in quarter four, beyond the anniversary of the start of the slowdown in November 2015, means that we expect the cyclical slow-down in spending on clothing and footwear to continue into next year," says Next.

Inflation may also cause a squeeze in consumer spending and "depress sales", and it still expects to raise prices by about 5%, as the weak pound increases costs, which will knock 0.5% off the top line in 2017/18.

If Next is right, expect a best-case increase in full price sales at constant currency of 1.5%, or a worse-case decline of 4.5%. At least weaker sterling should boost the actual outcome by 1%.

With extra costs of £29 million - the National Living Wage, business rates revaluation, wage inflation and website improvements - pre-tax profit is tipped to fall as much as 14% to £680 million and be not better than £780 million, a 2% decline.

"The central debate here is generic to the UK clothing retailers, though: is physical capacity correctly set, given that at least part of the peak season miss is likely to have reflected continued switching online," explains Next fan and Haitong Securities analyst Tony Shiret.

"As a sub-set of that debate, did Next Directory take its share of that switch, given that some of the 5% growth there in fourth-quarter will have come from international and some from improved availability?"

Dividend sweetener

In an effort to stem the exodus of shareholders and with Brexit and the clothing sector causing great uncertainty, Next says "it makes sense to give some additional certainty to shareholders over cash distributions".

With lots of spare cash sloshing around - £255-345 million in 2017/18, according to its own estimates - bosses think four quarterly special dividends of 45p each will do the trick; that's the cash it will generate at the lower end of guidance.

For shareholders who are sticking with Next through this awful patch and, assuming conditions don't deteriorate further, expect the first special to be paid in May.

Clearly this sweetener is not enough for many investors. Next shares crashed from 4,770p last night to a low of 4,090p Wednesday morning - exclude the brief post-referendum plunge and that's the lowest since March 2013. They've now halved in the past 13 months.

Bundled with an ordinary dividend of around 160p, Next offers a prospective yield of 7.9%Analysts have rushed to slash forecasts and, even after nudging back up to around 4,300p mid-morning, Next still trades on about 10.5 times Investec's earnings per share (EPS) estimates of 408p for the coming year.

That's a big discount to the 10-year average of 12.6 times; "not expensive, but not cheap enough" for Investec who thinks a 25% discount is appropriate, forcing a 15% downgrade to 3,900p.

Shiret, on the other hand, thinks the initial reaction has been "too severe". 2017/18 should be the worst year for most clothing retailers, he says, certainly in terms of having to adjust to an "exogenous shock to the system from sterling's fall".

But Shiret likes the valuation and points out that a return of 180p a share in special dividends means next yields 4-4.5% on that basis alone. Bundled with an anticipated ordinary dividend of around 160p, Next offers a prospective yield of 7.9%.

That's hugely tempting. Only thing putting investors off here will be fears of further deterioration in business beyond the current gloomy forecasts, and that a third profits warning is inevitable.

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.