Next races to 10-week high

There is a palpable sense of relief in City circles Thursday following Next's latest trading update. It's been a shocking 20 months for the clothes chain, but a dramatic market reaction to better-than-feared second-quarter results shows just how much bad news is baked into the share price.

Next HQ has the warm weather in June and July to thank for the beat. Full-price sales at the high street stores fell 7.4% in the past three months, less than expected, while the online business grew at 11.4%, twice as fast as forecast. It's why the shares trade  up as much as 12% at levels last seen in May.

Inflation, higher costs, weak consumer confidence and online rivalry have made life tough for Next, but it also took its eye off the ball, neglecting its bread and butter ranges. It won't always be able to rely on the weather, either, which can also work the other way as it has in the past.

Management is rightly cautious, and expects no further improvement in the second half, which means no change to existing full-year profit predictions of £680-£740 million. However, there's clearly an opportunity for Next to pull something out of the bag here.

Investors expect so little from Next that results like these cause significant share price movements. First-half figures in September will be watched closely for confirmation that improvements in the past couple of months are more than luck. Like today, shareholders will be richly rewarded if it is.

Next's share price chart just got interesting too. Thursday's surge caused a break above the downtrend drawn from the December 2015 high above £81, and above the 200-day moving average, currently at £42.78. These now become major levels of technical support in the event of a subsequent reversal.

There's also a strong valuation argument here. Even after today's rally extended three-week gains to as much as 25%, Next shares are hardly expensive.

Barely into double-digit valuation multiples, Next trades at a big discount to both the sector and its own 10-year average. A re-rating wil close that gap if this performance becomes a trend. There's also an attractive dividend yield, including at least two further promised special payouts of 45p each from surplus cash.

Analysts at both UBS and Investec still rate Next shares a 'buy' up to £49 and £47.50 respectively.

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.