For most shares in the FTSE 100, 2013 was a good year and investors have likely enjoyed capital gains and rising dividend income.
That makes me nervous about investing for 2014 and beyond, and I’m going to work hard to adhere to the first tenet of money management: preserve capital.
To help me avoid losses whilst pursuing gains, I’m examining companies from three important angles:
- Prospects;
- Risks;
- Valuation.
Today, I’m looking at UK-based fashion and accessories retailer Next (LSE: NXT).
Track record
With the shares at 6355p, Next’s market cap. is £9,837 million.
This table summarises the firm’s recent financial record:
| Year to January | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Revenue (£m) | 3,272 | 3,407 | 3,298 | 3,441 | 3,563 |
| Net cash from operations (£m) | 449 | 572 | 452 | 526 | 659 |
| Adjusted earnings per share | 156p | 188.5p | 221.9p | 255.4p | 297.7p |
| Dividend per share | 55p | 66p | 78p | 90p | 105p |
1) Prospects
When I last wrote about Next in April 2013, I thought the shares were fairly priced against earnings’ growth and dividend yield expectations. Since then, the shares are up about 46%, helped by strong sales, rising earnings and a share-buy-back scheme designed to accelerate earnings per share.
In January’s trading statement the firm revealed strong fourth-quarter sales boosting overall year-to-date sales, which are 5% up on the year-ago figure. That doesn’t sound much, but operational gearing ensures that every pound of sales is a heavy hitter for profit once sales exceed fixed costs. Indeed, forward guidance is for full-year pre-tax profit to be up between 10% and 12.6% and those boosted earnings-per-share up between 21.6% and 24.5%, all reassuringly precise figures calculated to the nearest decimal place! We’ll have to wait until the release of the full-year results on 20 March to see how things panned out
The directors reckon the step-up in Christmas trade was down to improvements in the firm’s seasonal knitwear, nightwear and gift offer, along with increased customer-confidence in online deliveries leading to last-minute directory shopping right up to the weekend before Christmas. The final quarter of the calendar year is traditionally strong for fashion retailers, so recent sales strength seems unlikely to continue in double digits through the early part of 2014.
Looking ahead, the firm thinks brand sales will be up between 3% and 7% for 2014, similar to 2013’s likely result. So, with forward growth settling down, I’d expect the share price to settle down too.
2) Risks
Next warns that stagnant consumer earnings look set to crimp consumer spending despite likely continuing improvements in the wider economy. As such, the firm doesn’t expect a significant increase in total consumer spending in the year ahead. There’s also concern that a return to economic growth is likely to result in rising interest rates, which could moderate the spending of those with mortgages.
Next’s valuation looks stretched. Forward growth expectations have moderated and the P/E rating now looks out of kilter. I’d expect some P/E compression going forward. Indeed, the firm has put a stop on share buy backs in favour of paying special dividends. Why? Because it thinks the share price is too high.
Longer term, there’s always a risk with fashion retailers that the brand could go out of vogue leading to a sales collapse. Finally, it almost goes without saying that retailing is a highly cyclical business to be in, with all the risks entailed.
3) Valuation
City analysts following the company expect earnings per share to grow about 8% in 2014 and again in 2015. The forward P/E rating is running at around 16 for the firm’s 2015 year, which ends in January 2016. Those earnings cover the forward dividend 2.7 times with the payout expected to yield 2.3% for 2015.
What now?
Forward growth expectations are lower than they have been, but no one has told the share price, which seems to be behind the curve of those reduced expectations. Perhaps momentum has caused the share price to overshoot.
