Next shares rocket, but is rally sustainable?

A year ago, Next chief executive Simon Wolfson was battening down the hatches and warning over "exceptional levels of uncertainty" in the clothing sector. A Christmas profits warning sent shares 10% lower and set the tone for a difficult year, with Next noting as recently as November the presence of "extremely volatile" sales trends.

It's early days of course, but the language used in today's better-than-expected trading update is far more reassuring from an investor viewpoint.

While many of the old challenges persist, Next thinks some of these headwinds will ease as 2018 progresses. For example, the company forecasts that cost price inflation will reduce to 2% in the first half of the new financial year and disappear in the second half.

It is also budgeting for full-price sales next year to grow by as much as 4%, with the mid-point of its forecast range - growth of 1% - being a modest improvement on the 0.3% rise expected for the year to this month.

Analysts are understandably remaining cautious, particularly as part of the 1.5% improvement in full-price sales for the two months to Christmas Eve was likely to have been driven by the impact of colder weather.

The update failed to budge Cantor Fitzgerald from its 'hold' recommendation, while Investec Securities sounded a note of caution despite its continued 'buy' stance and 4,940p target price.

Investec analyst Alistair Davies said: "The reality is that even though Next's Christmas numbers are better than expected, the company has still had a tough Christmas."

He also cautioned against reading too much from the Next performance into other retail updates due in the coming days.

Even so, there was share price relief across the sector today as Next rose as much as 10% to 4,947p, Marks & Spencer added nearly 2% to 321p and Primark owner Associated British Foods improved 2% to 2,844p.

One of the most impressive features of the Next performance has been the continued growth of its online operation, which grew sales by 13.6% in the two months to Christmas Eve. This contrasts with a 6.1% drop in store sales.

With the amount of stock going into its end-of-season clearance down by 6% on a year earlier, Next now thinks it should be able to increase profits for the year to the end of January by £8 million to £725 million.

This figure is set to fall to £705 million in the following year as operational costs are likely to grow faster than sales. But even at this level of profitability, Next says it will able to generate around £300 million of surplus cash.

It will distribute this through share buy-backs, which have the potential to improve earnings per share by 1.1% in the 2018 financial year.

On current forecasts, Investec said Next was trading on a 2018 price/earnings (PE) multiple of 11, with ordinary dividend yield of 3.9%.

Investec's Davies added: "We see continued valuation support given the reliability and consistency of Next's cash generation as well as operational flexibility to deal with a challenging retail market."

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