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The bull case for Next plc

Photo: Dorsetdude. Cropped. Licence: https://creativecommons.org/licenses/by-sa/3.0/

Next (LSE: NXT) has released a third quarter trading statement that shows the company continues to struggle. Its Q3 sales fell by 3.5% when compared to the same quarter of the previous year. While disappointing, Next could turn around its performance and now may prove to be an excellent time to buy.

Its third quarter was expected to be tough. The UK retail sector is in the midst of a very challenging year, with Q3 being particularly tough due to the uncertainty surrounding Brexit. Against this backdrop, Next’s performance was perhaps a little less disappointing than the headline sales number implies.

Still, Next’s Retail segment reported a fall in sales of 5.9%, while its Directory division recorded flat sales growth. Part of the difficulty for Next in this quarter was a tough comparison with the previous year, September being the company’s best month in 2015. In addition, August’s sales were held back by a large end-of-season sale in July, but October’s performance showed a marked improvement on the previous two months.

Looking ahead, Next has maintained its guidance for the full year. Although sales have disappointed somewhat, Next has been able to deliver better cost savings than previously anticipated. Overall, this means that the company is on track to hit its targets. This means that earnings are due to rise by 1% in the current year and then increase by a further 2% in the following year.

Focus on profitability

While this rate of growth is lower than that of the wider market, it shows that Next is able to increase its profitability even during tough market conditions. This is largely due to a sound strategy pursued by Next’s management team in terms of cost reductions and strategic pricing. However, it’s also because Next has a loyal customer base that hasn’t been enticed away by lower-cost alternatives. This should provide Next with a more resilient outlook than some retail peers.

Next currently trades on a price-to-earnings (P/E) ratio of just 11.4. Given its long-term growth potential and the quality of its business, this is a very appealing price to pay. Certainly, in the short run it could be hurt by uncertainty surrounding Brexit. But this creates an opportunity for long-term investors to buy Next when it has a wide margin of safety, which could enhance its total return.

Similarly, retail peer Sports Direct (LSE: SPD) could be a sound long-term buy. It trades on a price-to-earnings growth (PEG) ratio of 1.9, since its bottom line is due to return to growth of 8% in the next financial year. Like Next, Sports Direct faces an uncertain future thanks to Brexit, but unlike Next Sports Direct also faces political risk and a changing management team. This makes its risk profile higher than Next, with Sports Direct’s international operations also performing worse than anticipated.

As such, Next holds more promise than its retail peer. Although the immediate performance may be volatile, for patient investors, now could prove to be a perfect time to buy.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Sports Direct International. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.