Next is likely to see an improvement in performance after a disappointing first quarter due to the cold weather, according to City analysts.
Notwithstanding the current downpours, the better weather in May is likely to give the fashion retailer a boots, says Michelle Wilson at Berenberg. But further out she believes Next will have to close stores as the Directory continues to steal sales from the high street. Cutting earnings forecasts and target price but retaining a hold recommendation, Wilson says:
The introduction of a mobile-adapted website in March and normalising weather conditions in May will remove much of the temporary headwinds that have weighed on Next’s recent performance in our view.
However, over the longer term, we believe Next’s changing customer base presents a significant structural challenge. As Directory growth continues to cannibalise Retail sales growth, we believe management must close stores in favour of offering free home delivery or face continuing revenue pressure. Concurrently, the shift in mix from higher-spending, more profitable account customers to less-loyal cash customers is also having a negative impact on revenue growth and profitability.
As management continues to protect profitability over market share, we cut our earnings per share estimates by 6%/5%/5% in 2017/2018/2019 respectively, driven by weaker revenue expectations. We cut our price target to £48 from £73 and re- iterate our hold rating.
In more detail, Berenberg says:
Store estate is squeezing profitability: Next Retail like for like sales have been negative in all but one of the last five years. With 55% of Next’s Directory orders collected from store, we believe Directory growth is simply cannibalising Next’s Retail revenues and putting pressure on margins. To offset the impact on profit, management has opened larger, more efficient stores, offering free click-and-collect and charging for home delivery. While this continued space expansion is positive for profit growth in the near term, we believe a better allocation of capital would be to close stores in favour of free home delivery.
Home delivery sales are declining: We estimate that Next Directory home delivery revenues have declined by around 6% per annum over the last four years. Historically, this decline has been more than offset by an increase in click- and-collect orders; however, we believe that as i) consumers have become increasingly comfortable with shopping online and ii) the online proposition of retail peers has improved, consumer preference has increasingly shifted to home delivery.
As such, we believe UK Directory growth will remain challenging for Next as management continues to protect margins. Offering free home delivery would be painful in the short term, diluting Directory EBIT margin by around 4 percentage points, but it is essential to adapt to changing consumer demands in our view.
Loyal account customers are declining: Next account customers spend around £476 per annum with Next, of which we believe £404 is from product sales. This compares to an average cash customer spend of £210. The near- term negative impact of a decline in the number of account customers has been offset by the rising debts of the account customers that remain. Our concern is that this trend is unsustainable. As a result, Next may face further revenue pressure and an increase in bad debts.
