Should investors do the unthinkable and dump Next plc?
For years, Next(LSE: NXT) enjoyed the sort of performance that most investors crave, generating consistently higher profits, offering reliable and growing dividends and scoring high on quality measures such as return on capital employed (ROCE). This didn't go unnoticed with the shares rising from 2,469p fives years ago to a high of 7,958p in November last year. That's an increase of over 300%.
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Unfortunately, Next's track record of consistent earnings growth appears to have come to an abrupt halt for a number of reasons. Perhaps chief among these is the radical change in consumer behaviour. The rise in internet shopping has become so great that it now seems pertinent to ask whether investors should consider loosening their grip on a company that has rewarded their loyalty so well for so long and transferring some of their capital to more nimble online operators such as ASOS(LSE: ASC) or boohoo.com(LSE: BOO).
Troubled times
Make no mistake, today's half year results were anything but disastrous, especially as the company reported group sales up by 2.6% to £1957.1m. Profits at Next's Directory business were also up by 10.9%. Nevertheless, the 1.5% drop in overall pre-tax profit to £342.1m (including a rather ominous 16.8% fall to £133m from its retail division) suggests that trading conditions are only likely to get tougher for the Leicester-based company. The lacklustre performance on the high street therefore makes its decision to open new stores (albeit after closing less profitable ones) and increase net trading space by 350,000 square feet all the more surprising.
Next said: "At a time when retail sales are moving backwards, it may seem counterintuitive to be adding new space. Our view is that, in a difficult trading environment, taking new space is one of the few ways to mitigate losses from negative like for like sales."
Given the hyper-competitive industry it operates in and the fact that online sales figures were far more encouraging than those generated from its stores, I'm not sure this is the best course of action for Next at the current time. The market appears similarly unconvinced with shares dropping over 5% earlier today. They were at 4,951p as this article was published.
Cheap for a reason?
Taking into account the performance of listed peers like Debenhams and Marks & Spencer, I firmly believe that Next remains one of the best run businesses on the high street. Its long history of under-promising and over-delivering has served it well for many years and, while today's results weren't overly positive, the company still looks to be the best of an increasingly fragile bunch. With the shares now trading on an enticingly cheap valuation of roughly 11 times earnings, it's understandable if contrarians become tempted. The well-covered forecast dividend yield of 4% may also attract those looking to generate income from their investments.
That said, the shares aren't for me. At a time when many major companies (not just retailers) are struggling to grow earnings, I'm drawn to smaller, asset-light organisations with flexible business models. Indeed, the very real migration of consumers from the high street to the internet is why I believe pureplay online companies can't be ignored. True, ASOS and boohoo.com may target different consumers to Next and also trade on unnervingly high valuations (forecast price-to-earnings ratios of 62 and 55 respectively). But their competitive pricing, growing international presence and sheer convenience leads me to suspect that they will go from strength to strength in the coming years.
The elephant in the room
Things look rather bleak for high street retailers and their shareholders at the current time thanks to the stratospheric rise in the fortunes of online competitors. Despite its best efforts, it looks like Next isn't immune to this.
But that's not the only potential problem facing Next and some of our best-known companies. As things stand, we're still unsure as to how Brexit will affect our economy. As politicians continue to argue about how to proceed after June's momentous result, investors are growing increasingly concerned about what all this uncertainty means for their hard-earned wealth.
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Paul Summers owns shares in boohoo.com. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended boohoo.com. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
