Has the Next (LSE: NXT) collapse created a buying opportunity for value investors? I’ve spent some time looking at the group’s figures this week, and believe that the fashion retailer is starting to look cheap on a number of levels.
Today, I’m going to highlight three of the factors that are attracting to me to this stock.
The standard way to value retailers is on a multiple of their earnings. Next currently trades on a trailing P/E of 9.2, and a forecast P/E of 9.4. On this basis, the shares are clearly attractive. The only problem is that these profits seem likely to fall this year, for several reasons.
The first of these is that sales are falling. Total sales fell by 1.1% last year. Although management was hoping that sales would turn positive in the final quarter, this didn’t happen. As a result, Next says it expects “the cyclical slowdown in spending … to continue into next year”.
A second problem is that clothing purchase costs are expected to rise by up to 5%, due to the weaker pound. Operational costs such as the National Living Wage will add £13m to Next’s cost base this year, while the group also plans to spend an extra £10m on marketing.
I expect Next’s profits to fall next year. The latest consensus forecasts suggest earnings of 415.8p per share, which is 4.2% below forecasts for the current year. I’ve gone further and have modelled a 15% fall in earnings per share in 2017/18.
This may seem extreme, but if Next’s profit margins are squeezed as a result of rising costs and falling sales, profits could fall fast. I’d rather be too cautious. My model suggests earnings of about 370p per share for the coming year. This equates to a P/E of 11 at the current share price, which seems reasonable to me.
Next has always been very disciplined and transparent about how cash is returned to shareholders. The group uses a mix of share buybacks and dividends, depending on market conditions.
In Wednesday’s update, Next said that it plans to pay four special dividends of 45p next year. This gives a total payout of 180p. These payouts are expected to be backed by cash flow and equate to a yield of 4.4%, which seems attractive to me.
Most of Next’s stores are in leased retail units, so the group doesn’t have much in the way of property assets. But what it does have are loans totalling £1bn, to customers who buy on credit.
During the first half of last year, these credit sales generated interest payments of £105m. That’s equivalent to an interest rate of 22%. I’ve checked, and Next’s website confirms that the APR on its credit accounts is 22.9%.
Next’s debtor book should generate interest payments of more than £200m this year. That’s around a quarter of the group’s operating profit. In my view this debt is an attractive asset. It generates a significant level of profit and could also be sold and used to clear the group’s own debts, if this ever became necessary.
Today's top retail buy?
Next has gone onto my watch list. But high street retailers are operating in a tough environment. You may want to focus on companies whose sales are rising, not falling.
One example is the FTSE 250 retailer chosen by our in-house analysts for A Top Growth Share From The Motley Fool. Our experts expect profits to rise sharply this year.
Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.