Contrarians pile into Next despite grim rhetoric

Well, I did warn last week that investors should “buckle up” ahead of Next’s annual results this Thursday. In truth, I didn’t expect much from the numbers given January’s shock profits warning and uber-gloomy outlook. I certainly didn’t anticipate a 9% share price rally to an 11-week high, especially as there’s still plenty to fear.

By 9:20, Next shares had traded as high as 4,248p. They hadn’t seen those levels since 4 January and a terrible set of fourth-quarter figures in which chiefs warned that profits will fall, and keep falling.

They were true to their word, reporting a 3.8% decline in underlying pre-tax profit for the 12 months ended January to £790 million – the first fall in eight years - roughly in line with reduced guidance issued at the start of this year. Previously, Next had hoped for as much as £825 million.

High street profit made particularly grim reading, down almost 16% to £339 million, offset partially by online shoppers driving a near-10% uptick as the Directory business. However, Next brand sales were flat at £4.03 billion for the 52 weeks, as a 4% rise in catalogue revenue cancelled out a 2.9% drop in retail sales to £2.3 billion.

Retail net margin fell 220 basis points to 14.7%, mostly a result of weak like-for-like sales, which will trigger further erosion to 12% this year, we’re told.

A further decline in Next’s hugely profitable credit customer base is worrying, too. Yes, the rate of attrition has slowed since it began actively marketing credit accounts to existing and new customers in January 2016, but year-on-year comparisons get tougher now, and there’s likely to be at least a “modest” decline this year.

And company rhetoric hardly rouses a buying instinct.

“We remain extremely cautious about the outlook for the year ahead,” writes chief executive Lord Wolfson. “The clothing sector faces three potential threats: a sectorial shift away from spending on clothing, price inflation as a result of sterling's devaluation and potentially weaker growth in real incomes in the wider economy.”

He’s right, of course, and an internal cock-up meant Next dropped some of its best-selling products. That error won’t be fixed until the autumn season, so first-quarter sales will be toward the bottom of the range of estimates, although Wolfson bets on a “more marked improvement in the second half”.

Even if things go to plan, Next will make less than last year – between £680 million and £780 million of pre-tax profit in the year to Jan 2018, equal to a decline of 1.3-13.9%. Full-price sales at actual exchange rates will rise no more than 2.5%, but could fall as much as 3.5%, according to internal sums. Without share buybacks, EPS could be down up to 12.4%.

On the plus side

Despite some grim stats, crucially, there was no further warning or downgrade to guidance, and the full-price sales forecast was no worse than its previous guess.

There’s that fat dividend, too. Expecting to throw off much more cash than it needs – look for a £300 million surplus - Next promised in January a series of four quarterly special dividends of 45p each worth £255 million. The first of these will go ex-dividend on 6 April.

Over the next 12 months, management predicts ordinary dividends will remain roughly the same. Add it all together and Next currently yields around 8%.

Contrarians will also argue that a lot of bad news is already priced into the Next share price right now.

Take the mid-price of EPS guidance for Jan 2018 at around 413p, and Next shares trade on a forward price/earnings (PE) ratio of just 10. That’s not expensive. Indeed, it could look very cheap further down the road. A year ago it was 13, a multiple which would value the shares at over £49 now.

And retail sales data, published by the Office for National Statistics Thursday, appear to show a more resilient UK consumer, despite rising inflation and timid wage growth. Sales jumped 1.4% in February, over three times more than expected. Look at the three-month picture though, and the trend is down.

So, which way now?

That yield is certainly attractive, and the shares cheap. But this does assume that Next avoids any further shocks, and that numbers at least meet the middle of guidance.

Outgoing chairman John Bartron has tried to rekindle memories of 2008 when profits fell and the share price halved. “By the following year our profits had started to grow again and our share price recovered strongly in the following years,” he reminds us, trying to rouse the faithful. “By focusing on our core strengths, as we did during 2008, we will see Next emerge from this period stronger than before.”

It’s a nice thought, and, yes, Next maybe worth much more than it is now, some day. But it's unlikely to be soon. A bottom certainly looks to be in at around £38, but if the consumer does wobble, so will Next, destroying any hope it has of filling that gap-down in the share price from £50 in January.

Time to watch the inflation data like a hawk.

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.