During 2013, UK-based fashion and accessories retailer Next (LSE: NXT) posted an impressive 23% rise in earnings per share, but 2014 seems set to come in with growth sharply lower.
Looking forward, projections on earnings are less rosy than we are used to with Next. The forecasts show signs of declining expectations, which could end up pressurising the firm’s lofty looking P/E ratio.
Next faces trading headwinds, and if lower rates of growth become an enduring feature, there’s every reason to expect the share price to remain stagnant for some time. The firm’s 2.5% forward dividend yield will provide some comfort, but the outlook for investor total returns seems uncertain. If I sat on a big gain with Next, I’d be inclined to lock some of that in by selling.
Squeezed customer earnings
Next’s earnings rose, along with the share price, for several years. The firm’s two-pronged attack on the fashion clothing market, through both retail stores and via catalogue sales, delivered some impressive growth figures:
| Year to January | 2010 | 2011 | 2012 | 2013 | 2014 |
|---|---|---|---|---|---|
| Revenue (£m) | 3,407 | 3,298 | 3,441 | 3,563 | 3,740 |
| Adjusted earnings per share | 188.5p | 221.9p | 255.4p | 297.7p | 366.1p |
| earnings-per-share growth | 21% | 18% | 15% | 17% | 23% |
However, forward growth expectations are lower. At the moment, City analysts following the firm expect earnings to come in up 9% year to January 2015, up 9% to January 2016, and up 8% the year after that. Projections like that leave the share price looking over-extended. At 6,945p, the share price is running at a forward P/E multiple of nearly 16 for the firm’s next trading year. That’s much higher than the rate of earnings’ growth.
The directors cite the continuing squeeze on consumer earnings as one reason for reduced growth. Recent news is that some of the downward pressure on citizen’s spending power is easing in Britain, and the directors point to low inflation, an end to real wage decline, healthy credit markets and strong employment as reasons to be more positive than in recent years.
However, it still feels like the free-spending momentum of the last decade might be years away, if it ever does return. Earnings growth looks set to be harder to achieve going forward, and one risk is that Next’s P/E rating might contract to accommodate that.
Fashion risk
Next’s strong brand identity drives sales and it seems that many customers buy Next over other brands because they want to be associated with what seems like quality and style. Wearing Next seems to be fashionable, but that situation carries risk, because the popularity of fashion brands can fall. If wearing next should become less hip, the firm’s growth could stall.
What now?
Although the sales momentum seems reliable, Next shares look pricey, and we mustn’t forget that there’s a big element of cyclicality in non-food retailing.
