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Here’s what I’m doing about the Next share price

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On 1st April, Next (LSE: NXT) released its results for the last fiscal year (2020/2021). As expected, the results were not pretty. Sales for the clothing retailer declined 17% and net profit declined a huge 53%. Despite the bleak news, the Next share price closed up over 3% for the day due to the management’s optimistic outlook for the future, saying the company should recover strongly towards pre-pandemic levels this year if all goes to plan with the easing of restrictions.

Such optimism has led some to believe that Next is the perfect ‘reopening stock’ for the post-pandemic economy. I am not quite so sure of this, however.

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The positives: online growth

One reason Next shares seem attractive is because its online business is growing at a fast pace. Over the last decade or so, there has been a strong shift towards buying and selling clothes online. Next has benefited from this hugely. Today, its online business accounts for over 65% of the company’s total sales. This is up from 32% in 2012.

The pandemic has accelerated this trend as many people have been forced to turn to online platforms to do their shopping. This was the driving factor behind the 10% sales growth that Next’s online business saw last year. This figure, however, is deceiving as it includes the first lockdown when Next’s online (and retail) business was brought to a near standstill. In reality, the online business is growing at a much faster rate, achieving year-on-year growth well in excess of 30% over the last quarter of the year.

Management also think this high rate of growth is likely to continue. They predict that online sales will grow by 31% this year. Given the higher margins associated with the online business compared to the retail business, such growth could cause both profits and the Next share price to explode!

The negatives: retail decline

It’s not all good news for the future of Next, however. The company’s retail business, which accounted for 26% of total sales last year and 42% the year before, is in structural decline. As more and more people shop online, fewer people are shopping in store. This trend has impacted Next’s retail business significantly. In the five years preceding the pandemic, Next’s retail business contracted 5% per year.

Management also expect this trend to continue. In the annual report, the decline in year-on-year retail sales was described as “the new normal” and expected to persist “for many years”. As retail still represents such a large part of the company’s revenues, this decline will be a drag on future profitability. In fact, it has already been a drag for a while now, and is part of the reason Next’s overall revenues and profits have stagnated since 2016.

Valuation

At the time of writing, the Next share price stands at 8,080p. Using management forecasts, this puts the company on a one-year forward price-to-earnings (P/E) ratio of 18.7. With the FTSE 100 having a forward P/E ratio of just 14 at the start of the year (it hasn’t moved much since), this valuation seems high. For me, the shares are not low enough to compensate for the declining retail business. As such, I am not buying Next shares for my portfolio just yet.

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Ollie Henry has no position in any shares mentioned. The Motley Fool UK has no position in any 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.