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One fast-growing competitor I’d buy ahead of Next plc

Fashion retailing has always been an incredibly tough business and recent shifts in consumer habits have made it even more challenging for retailers. Yet, while the likes of Next (LSE: NXT) blame their relatively poor trading on this gloomy sector outlook, some competitors such as Superdry parent SuperGroup (LSE: SGP) continue to grow at a double-digit pace without batting an eyelid.

Growth galore 

In the half year to October, SuperGroup revenue rose 20.4% year-on-year to £402m driven by increased same-store sales, the opening of new outlets and £12m in benefits from the weak pound. Now, gross margins did fall by 170 basis points during the period due to input cost inflation and very good performance from franchised wholesale stores, which produce lower margins for the parent group.

While they may come with lower margins, these franchised stores are still a smart investment. They allow management to focus on developing the brand and increase the speed at which the group can open stores in growth markets such as the US and China. Evidently, management’s focus on brand development is working as like-for-like sales rose a very solid 6.3% across the portfolio during the period.

Now, this rate of growth is slower than the 15.4% posted in the period before and future performance should be followed closely by shareholders, but it’s still a good sign of positive momentum for the brand. Management also disclosed that it expects to hit consensus analyst estimates for full-year pre-tax profits of around £98m, which would be 16% ahead of the year before.  

Maybe next year?

In opposition to SuperGroup’s cheery update, Next’s management team sent the group’s stock price downwards after its Q3 update earlier this month due to a pessimistic outlook for the critically important holiday shopping season. Full-price sales in Q3 were decent and rose 1.3% y/y as Directory sales grew by double-digits and compensated for a large decline in Retail sales. Yet the company’s share price still retreated by some 7% on the day results were announced.

That was because year-to-date sales were down 0.3% and management said it expects Q4 sales to reduce by a similar amount with full-year earnings per share down anywhere from 10% to 3.5%. This fits in with consensus analyst estimates of an 8% drop in EPS that would put Next on a valuation of 11 times forward earnings.

This may appear to be an attractive price for the company given that analysts expect it to pay out some 335.81p in dividends this year that would yield roughly 7.5% at today’s share price. But with sales in retreat and few signs of management figuring out how to staunch the bleeding in the company’s huge estate of retail stores, I’d be hard pressed to invest in Next at this point in time.

Although the clothing sector scares me due to its cyclicality and reliance on ever-changing consumer habits, if I were to invest in the industry, SuperGroup would be near the top of my list due to its rollout potential, despite its shares trading at an elevated 19.5 times forward earnings.

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Supergroup. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.