“Modesty” goes a long way
A ‘modest’ upgrade it may be, but Next's (LON:NXT) improved assessment of the effectiveness of remediation efforts has gone a long way to repairing sentiment. The announcement of a further share buyback is officially new though we had spotlighted the strong possibility of it occurring judging from management hints at the time of the last trading update on 3rd August. We don’t think we’re alone in already having priced in another cash return. The stock was flat since early August before today’s surge, having jumped on the prior update. It therefore makes sense to attribute Thursday’s rise of as much as 13% largely to confirmation of the group’s digital growth.
The 1.2% decline in full-priced sales leaving total sales 2.3% lower on the year was also already reported with the second quarter update, so attention should rather be on details below headline outcomes. Of these, the breakdown of Next’s newly segmented online shop, Directory, steals the show. Full-price sales via Label, the group’s outlet for third-party brands rose 40.6% in H1, accelerating almost 20 percentage points to 50.4% between the end of Q1 and end Q2. It’s this corroboration of the encouraging seam first spotlighted in August that the market is reacting so well to; perhaps overreacting so well to, admittedly.
Keeping faith in stores
Whilst Next's interim commentary underscores the digital uplift, by noting only "marked divergence" between stores and online sales the group remains obdurate—officially—in the face of long-term structural headwinds that stores face. The group has only let an extensive store opening and refit programme ‘slip’ (it suggests unintentionally) by a modest amount. Even so, store efficiency also slipped. Next accepts it “overestimated the uplift on sales that could be generated from the cosmetic element” of upgrading a handful of stores. These failed to meet targets after extension and refit. The group indicates that allocating upgrade expenditure to capital instead of cosmetic capex was also a misstep. It looks like a minor one. However, we will keep an eye on medium-term annual cosmetic capital expenditure as it is now expected to rise to an average of £16m annually from £11m. All told, whilst barely concerning. The store efficiency downtick demonstrates that Next’s decision to push ahead with physical space expansion will frequently be challenged.
Margin watch
Margin erosion, a bigger concern, has, again, also been all but directly flagged throughout the half year. If anything, the 290 basis point reduction of Retail margin guidance to 11.8% looks increasingly provisional given the turnaround of efficiency in warehousing/distribution, printed media, central overheads and markdowns. Even excising the ‘easy’ comparable third quarter in 2016, improved sales and unbudgeted savings (offset by weak clearance) will still have pushed annual profit up £7m, albeit the weather has been on Next’s side. We assume more intemperate winter conditions into year-end but still see a re-rating as increasingly overdue.
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