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Is the Next share price the bargain of the year?

Fashion retailer Next (LSE: NXT) is well known as a high street survivor. But long-time investors may wonder if this firm is now in a long-term decline, given the difficulties faced by many retailers.

Today I want to consider this question and explain why I think Next shares could be a great investment.

Nobody does it better

Next published its annual results last week. These showed that the retailer’s total sales rose by 2.5% to £4,220.9m last year, while its pre-tax profit edged down £3.2m to £722.9m. These figures confirmed that the group is still trading well, despite most rivals complaining of tough conditions.

I won’t go into the results in too much detail — my colleague Graham Chester covered them here — but I do want to highlight two of the secrets to Next’s success.

The first of these is the way the group is managing the shift to online sales, which rose by 14.7% to £1,918.8m last year. This £246m increase outweighed the £168m fall in high street sales and lifted the group’s online profits by 14% to £353m — more than half the group total.

The second part of Next’s business that’s essential to its success is its customer credit operation, now branded as nextpay. About 60% of UK online orders are made on credit and the group’s finance business delivered £121m of profit last year. That’s about 16% of the group’s operating profit.

Yes, but what about the shops?

Next’s rapid online growth is all very well, but what about its shops? Shop sales fell by almost 8% last year and the company has admitted it’s planning for a long-term sales decline of 10% per year on the high street.

Here’s where things get really clever. The first thing to note is that 80% of online returns are handed in at Next shops, where customers can avoid postage hassles and get instant refunds. So we see that the shops have a purpose beyond retail sales.

The second clever thing is that Next has worked out how to manage and evolve its store estate to maximise future profitability. To cut a long story short, over the next 15 years the company expects to shut some stores, open others (new stores perform better) and run some at a loss as online return points.

£12bn in cash?

Next believes that operating the business in this way will deliver £12bn of pre-tax cash flow over the next 15 years — that’s more than the group’s current market cap of £7bn. Much of this cash is likely to be returned to shareholders.

Details of this “fifteen-year stress test” were included in last year’s results. The company’s assumptions all seem realistic to me and it’s clear that Next’s boffins have been very thorough.

Other retailers may have similar plans — but none have the courage or transparency to share them with investors in this way. I think it’s a great example of why Next is an attractive share to own.

I’m also tempted by the stock’s modest valuation. Although the shares have bounced from the £40 low seen at the end of last year, Next’s forecast price/earnings ratio of 12 and 3.1% yield seem reasonable to me for such a profitable business. I see this as a good long-term buy.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.