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3 reasons I wouldn’t add Next to my portfolio

Rarely does a company do everything right and still be in danger of getting it wrong. Next (LSE: NXT), currently the largest clothing retailer in the country, has been implementing a strategy to salvage its business and weather the storm of disruption for nearly half a decade.

Now it seems the company has finally hit an inflection point and things could be looking brighter. Recently it said total group sales expanded for the first time in three years. Sales for 2019 were up 2.5%, as the 14.7% spurt in online sales offset the 7.9% decline in retail revenue. Consequently, the stock is up 35.2% since the start of this year. 

However, I’m not convinced by this turnaround story. Here are my three reasons for avoiding Next, despite these green shoots. 

Digital competition

The global retail landscape has changed beyond recognition over the past decade. Now, the world’s largest retailer, Amazon, is one of the most valuable companies on the planet with resources that are matched by only a handful of others. 

Meanwhile, smaller digital native companies like Shopify and Flipkart have tightened their grip on their niche. In other words, the competition for e-commerce sales is at a historic high. Carving out a chunk of this market internationally as Next wants to do isn’t going to be easy, despite its UK strength. 

Nevertheless, Next plans to do just that. In its recent annual report, the company claimed its long-term strategy was to expand online sales in more countries to sustain growth. To achieve that, the company will need a competitive advantage I feel it currently lacks. 

Lack of moat

There’s no doubt that unique fashion and a recognisable brand are competition advantages, but I believe Next will struggle to replicate its success overseas. The brand isn’t that well known beyond the UK and the company’s product range is, as far as I can tell, undistinguished from other large retailers. 

I also feel Next doesn’t have the technology or logistics prowess of Amazon, the capital-light business model of Shopify, or the cost efficiencies of Zara to compete with them on a level playing field. 

But even if I’m wrong and Next can sustain its double-digit expansion overseas, it won’t be enough to offset the oncoming crisis in Britain’s retail sector.

Domestic exposure

The majority of its sales are generated domestically. Only 16.6% of sales this past year were from overseas. That means the company is overexposed to the economic repercussions of Brexit this year and beyond, although its boss’s enthusiastic support for Brexit means it’s probably one of the best-prepared retailers for that event. 

Even so, if the pound depreciates or the country reverts to tariffs on trade under World Trade Organisation (WTO) rules, the retailer’s bottom line will certainly suffer. I doubt that double-digit sales growth in its relatively modest overseas business would be enough to offset this domestic turmoil. 

Foolish takeaway

Next has done everything right to sustain its business over the past decade. Its focus on online sales and overseas expansion is commendable. However, I believe the growth in online sales is too little in current circumstances. Meanwhile, the company will need to make significant acquisitions or marketing investments to sustain growth abroad, while the domestic business is hit hard by Brexit issues. 

Put simply, I think there are better investment opportunities than Next at the moment.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. VisheshR has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon and Shopify. 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.