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24 April 2012
Next Plc
Where next?
We believe Next is likely to experience increasing pressure both on top line and margin in the next few years as online competition grows and the apparel market shifts increasingly to a free delivery model. Slower growth in Directory and continued Retail weakness would weigh on profits as scope to flex costs appears limited and it is not impossible to see a decline of 30% or more in Retail EBIT, which would be negative for sentiment. Next currently sits at a premium to the sector on 12.3x CY12E PER; our 12M TP of 2039p has 33% downside. Brand LFL has been negative over the last 8 yrs. Nexts track record of delivery has been impressive driven by new space and strong Directory growth. However, on a combined Brand basis (Retail and Directory) densities are still down 44% since 2003 and ex new space, Brand LFL has declined fairly consistently over the period. Directory is over-penetrated online in our view with an estimated online market share of clothing of c. 14.5% significantly higher than its pure bricks & mortar share of 5.3%. Ability to further flex opex appears limited. With new space and Directory growth set to slow from FY14E onwards, we see risks to estimates, particularly given limited ability to flex Retail costs as Directory slows. Brand opex per sq ft is down 40% in last 9 yrs reflecting staff savings. Free delivery if adopted would cost 18% of group PBT. Directory margin appears to have peaked. Cash customers are c. 8% less profitable and a potential market shift to free delivery could ultimately cost 900bp of Directory margin and up to 18% of group PBT if Next followed suit. Retail downside. There are many moving parts and potential scenarios. Our assessment of the LFL needed in Retail to result in a 30% decline is -1.7% pa over the next five years; whereas to achieve break-even in Retail, LFL sales would need to decline by an avge of 5.5% pa over the period, only 1% worse that the 5 year historic avge (-4.6% pa). Valuation downside. The shares have historically been driven by earnings momentum; if negative this would adversely impact the shares, which are currently at a premium of 11.3% to the retail sector. Our 12M TP of 2039p is based on a blend of our estimates and scenario analysis (weighted towards our forecasts) and implies 33% downside.
Next Plc (NXT.L;NXT LN) FYE Jan Adj. EPS FY (p) Revenue FY ( mn) Adj EBITDA FY ( mn) Pretax Profit Adjusted FY ( mn) DPS (Net) FY (p) EV/EBITDA FY Adj P/E FY Net Yield FY EBIT FY ( mn) 2011A 206.43 3,454 703 551 78.00 8.4 14.5 2.6% 584 2012A 237.05 3,506 727 570 90.00 8.1 12.7 3.0% 607 2013E
(Prev)
Underweight
NXT.L, NXT LN Price: 2,999p
Georgina Johanan
(44-20) 7155 6157 georgina.s.johanan@jpmorgan.com
Helena C Sykes
(44-20) 7742 0932 helena.c.sykes@jpmorgan.com J.P. Morgan Securities Ltd.
Abs Rel
1m 0.0% 6.0%
3m 12.6% 11.2%
2013E
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2014E
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Company Data Price (p) Date Of Price Price Target (p) Price Target End Date 52-week Range (p) Mkt Cap ( bn) Shares O/S (mn)
See page 50 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.morganmarkets.com
Table of Contents
Investment thesis .....................................................................3
Summary Points......................................................................................................3
Where Next? .............................................................................6 One Brand, one dream does it matter where the sales come from?...............................................................................7
Next sales densities fall even on the combined business ...........................................7 Both new space and Directory are key for Brand sales growth..................................8 Directory has been the main driver of sales and profit in the last year .......................9 The switch to offering cash with order has provided a short-term boost ..............10 .., but Next is already over-penetrated online......................................................11 The growth in cash customers encourages cannibalization of the UK store customers .............................................................................................................................13 Overall market share in clothing appears to be stagnant..........................................13 Profit per sq ft has also been falling .......................................................................14 Scope to further cut costs appears limited ..............................................................15
Valuation .................................................................................40
ROICs...................................................................................................................40 Share price versus earnings revisions.....................................................................40 Valuation versus peers...........................................................................................44
Investment thesis
Summary Points
Nexts track record of delivery throughout the downturn has been impressive; reflected in the share price outperformance. EPS 4 year CAGR +9.2% between 2008 and 2012. Shares +39% in 2011, an outperformance of 50% vs. the sector. Growth has been driven by safe haven status and strong performance in Directory
Figure 1: Next vs. FTSE 350 General Retailers Relative Performance
1.9 1.7 1.5 1.3 1.1 0.9
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Directory performance reflects structural growth in the market BUT as a first mover Nexts is over penetrated online and looks set to lose share going forward. Next has a 14.5% share of the online clothing market, significantly higher than its 5.3% share of the bricks and mortar market. Risk of a loss in share is weighted to the downside. New Space and Directory are key for Brand sales growth. The average growth in Brand sales over the past 5 years has been +1.6% pa despite an average space contribution of +3% and an average contribution from Directory of +2% to total Brand growth. Cash customers have been a key driver of Directory Growth. Of 9.7% growth in active customers in FY12 (to Jan), 6.3% came from the increase in cash customers. BUT has tempted those hold-out Next Retail customers who did not like having to order on credit and is therefore encouraging cannibalization of store customers.
Directory margin could have also peaked. Free delivery becoming increasingly prevalent. Growth in less profitable cash customers/ increasing international mix (we estimate that account customers are at least 8% more profitable on average). Increasing international mix (margin on international customers c.350bps below UK customers).
Free Delivery could impact the Directory margin by 900 bps and reduce Group PBT by 18%. Moving to free delivery would mean that Next loses 3.99 of income generated from customer delivery charges on an estimated 15m parcels pa at present generating a one time hit of 59m. Combined with likely increased average order frequency and an incremental channel shift this equates to lost margin of c.900bps (over a 2-3 year timeframe). This compares to the cost to Asos of 1300bps from a shift to free shipping (although it has a greater proportion of international sales which will be more expensive). Nexts sales densities have been falling even on a combined basis. Combined (i.e. Retail & Directory) sales densities have fallen by 44% from a peak of 953 per sq ft in 2003 to 533 in 2012. We estimate cumulative underlying Brand LFL decline of -7.7% over the 8 years to 2012.
Table 1: Potential Impact on Group PBT if Current Paid For Deliveries Were Free
Directory sales inc VAT and grossed up for returns Collected in store (inc VAT) Delivered by courier Sales delivered by courier with free delivery Sales where delivery charge paid by the customer Directory customers (m) Average spend per customer pa Average order value Implied average order frequency pa Implied no. of parcels (m) pa - total Implied no. of parcels (m) pa - delivery paid by customer Standard delivery charge Current income generated from customer delivery charge 2160m 432m 1728m 259m 1469m 3.0 721 100 7x 22 15 3.99 59m 20% 80% 15% 85%
2013E
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Cost cutting is important to mitigate this pressure; scope to further cut costs appears limited. Management has achieved aggressive efficiencies in underlying costs. Per sq ft Brand opex has fallen by 40% in the 9 years to 2012 and Brand FTEs have halved to 4.1, which is lower than most peers.
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Our scenario analysis gives a range of outcomes; risks lie to the downside. Worst case scenario; to reach the tipping point into Retail loss, Next LFL Retail sales would need to fall by 5.5% on average over 5 years. A 30% fall in Retail EBIT would result if LFL Retail sales declined by only -1.7% on average over 5 years.
PBT expected to fall by 3% pa over the next 3 years This includes a fall of -1.6% in FY13E, towards the bottom of managements guidance range (-2% to +7%). 3-year EPS CAGR (including the buyback) +1.6% (FY13E +4.0%)
Valuation; Next is the most expensive stock within the peer group. Premium rating (CY12E PER of 12.3x) and PEG of 4.4x. Discounted profit model returns a value of 16.76 per share. Price target updated to 2039p based on a blend of scenarios.
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P/E CY12
Where Next?
Top performance in 2011 driven by safe haven status and Directory enthusiasm Next was the best performing stock in UK General Retail in 2011. The shares rose by 36% on an absolute basis and 49% on a relative basis as investors chose to back the security of a well regarded management team and a share buyback programme over the uncertainties of self help programmes or macro recovery stories elsewhere in the sector. However, it was not just about looking for a safe haven. Investor enthusiasm also appeared to be stimulated by the strong growth delivered by the Directory business and Directory's potential to offset the moribund Retail business and perhaps even deliver a growth angle for what had hitherto seemed at best to be a stable story. However, it seems that this enthusiasm has been carried forward into the current year with estimates and the valuation implying that Directory can continue to perform at this high rate of growth and offset the impact of a deteriorating Retail business indefinitely. We disagree with such a view for a number of reasons Firstly, Next argues frequently that given the cannibalization of the Retail business by Directory, we should look at the business as one combined entity: Next Brand. However, when we do so, we can see that the metrics still look less than appealing Secondly, we believe that Directory growth has been driven by several one-off factors in the last couple of years and that Nexts first mover online advantage leaves it little room to manouevre as competition online increases, especially given it is already over-penetrated online. Thirdly and importantly, we believe that Directory margin has peaked and that looking forward there are a number of pressures on margin including but not limited to negative mix effects from growth in cash customers and the potential introduction of free delivery. Fourthly, we believe that this view ignores the pressures being placed upon the retail business, where management's scope to further reduce costs in our view looks to be limited. In this note we aim to examine what we consider to be the main pressure points within the Next business, looking at the business on both a combined Brand basis as well as breaking the P&L down into its component parts to examine its ability to flex to meet a lower sales environment.
One Brand, one dream does it matter where the sales come from?
The positive argument in favour of investing in Nexts shares is based on the theory that it does not matter where the sales come from provided combined Brand sales are growing. However, our take is that such a view ignores several key factors: Growth in the combined Brand sales (ie Retail + Directory) has been driven by new space growth and ex this new space, Brand sales have been falling on a LFL basis Sales densities for the combined business have been falling consistently over time Directory has been the main driver of group sales and profitability in recent years and has been cannibalizing the retail business The more recent sales growth in Directory has been coming from cash customers, who are less profitable and who have come, we believe, from the Retail business
The two different channels, Retail and Directory have different cost structures, even though there is some cross-subsidisation of, for example, returns Brand EBIT per sq ft has fallen by 29% over the last decade despite the substantial improvement Next has delivered in gross margins Opex as a % of sales (for the combined business) has risen by 450bp over the last 10 years, despite considerable efforts by management to trim costs A persistent decline in sales densities in Retail will eventually lead to a tipping point in terms of the fixed cost base of the Retail business leading to declines in Retail profit
While we accept managements argument that the two businesses should be examined as one entity and indeed that is how we look at multi-channel businesses for other retailers, we equally believe that we cannot ignore the strains on store metrics of a falling sales base. This is discussed in more depth later in this report, but first examining the combined businesses as one, we see that perhaps, contrary to commonly held belief, the combined sales densities for Next Retail and Directory have been falling since 2003 (Figure 10) ie the growth in Directory is not outweighing the decline in Retail on a square footage basis. We estimate that the cumulative LFL decline in Brand sales has been -7.7% over the 8 years to 2012.
Both new space and Directory are key for Brand sales growth
Part of the decline in sales densities can be attributed to the decision by Next to open larger space stores, which do dilute density and also to the decision to roll out Home stores which also generate lower sales densities, but this does not explain the entirety of the reduction as even as space growth has slowed, densities have continued to fall (Figure 11).
Figure 11: Space change vs change in combined sales density
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0%
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Ex new space we estimate that the Brand has delivered a cumulative LFL decline of 7.7% over the last 8 years
Figure 12 looks at the absolute sales within Next Brand and the rate of growth being delivered and we can see that growth has decreased dramatically since 2002. The average growth in Brand sales over the last five years has been 2% pa despite the addition of 6.6% average new space per annum and growth in Directory. From this, we can see that, despite the headline grabbing growth in Directory, new space has been crucial for the growth of the Next Brand (Figure 13). Without it, sales would have been negative for the combined group in five of the last six years.
Figure 13: Brand sales growth yoy % less weighted space contribution
10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% 2002 2003 2004 2005 2006 2007 2008 2009 2011 2012 Brand sales grow th less weighted space contribution
Directory has been the main driver of sales and profit in the last year
c. 80% of Directorys sales are now online; most levers for growth appear fully utilised
Nexts Directory business has grown its sales by 12.4% pa over the comparable period and with c. 80% online penetration of the Directory sales base, we estimate that its fate is inexorably tied to that of the online clothing market. Growth in Directory in the past has been fuelled by two principal factors: an increase in the number of active customers and an increase in the number of pages. The average spend per customer is also a key factor, but as Figure 14 illustrates has fluctuated considerably over the last decade or so, tending to reflect the economic environment. For instance, it became negative in both 2005 and 2010/2011 as consumers retrenched in a more difficult environment.
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2012
Cash with order has been used to stimulate Directory growth since 2010
In the first of these dips, Directory sales growth was saved by a sharp increase in page count as well as active customers, whereas in the second, the introduction with a cash with order facility spurred growth in what had been a stagnant customer base for a couple of years. Having used both those levers, it is difficult to see what else can be used to stimulate growth from here.
The switch to offering cash with order has provided a short-term boost ..
As the economy worsened in 2008/2009 management moved swiftly, introducing cash with order with little fanfare in mid 2009 (FY10). This had the desired effect, as awareness grew, so did customers and of the 9.7% growth in active customers in FY12, 6.3% came from the 64% yoy increase in cash customers, with the remaining 3.3% from credit customer growth.
Figure 15: Cash with order customers and credit customers
3000 2500 2000 1500 1000 500 0 2006 2007 2008 Credit customers 2009 2010 2011 2012 Cash w ith order customers
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Our analysis suggests that Nexts share of online clothing is unsurprisingly higher than it is in the overall clothing market. This reflects its early entry into this market with an incumbent high customer base through Directory. This market share has been declining as new entrants expand online. Over time as all its main competitors build their online offering, we believe Nexts online share should trend towards the market share level it achieves of the overall market, especially once we bear in mind that the level of competition and choice on line will ultimately be greater than that in the physical store base which is naturally limited by geographic boundaries. Next's credit offering could provide some competitive advantage, however, by allowing it to maintain a higher share than it would otherwise, but we think it fair to say that further growth in online share seems unlikely and the risk of a loss in share is weighted to the downside. Figure 16 illustrates the growth both in Next's active customer base and in that of Asos over time and demonstrates we believe that Nexts first mover advantage is being eroded as other online retailers grow.
Figure 16: Next Directory Active Customers vs. ASOS
3,000 2,500 2,000 1,500 1,000 500 0 2009 Next '000s
Source: Company Data
We believe that Nexts online share should trend down over time
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Online share analysis Next does not disclose the percentage of Directory sales online or the percentage of Directory sales that are Homewares and hence we make a number of assumptions in this analysis. We conservatively assume that 85% of homewares sales, excluding those in standalone home stores, are generated through Directory in 2012 (growing steadily from 64% in 2003). We assume Home sales followed a steady growth trajectory between 2009 and 2012 (the two years in which Next disclosed this metric). We assume that 80% of Directory sales are now online (up in line with the trajectory between 2008 (almost 60%) and 2010 (70%).
We estimate Next has a 14.5% market share of the online clothing and footwear market
Based on the assumptions detailed above, Next has a c.14.5% share of the online clothing & footwear market (worth 4.5bn in 2012, source Verdict), down from 22% in 2007 (Figure 18) as other players started to penetrate the market. Next Retail has a much lower share of the clothing market (5.3% share of the total clothing market in 2009 per Verdict, Figure 17). This suggests that Directory is over penetrated online and that it would be difficult for the group to grow share from here.
Figure 18: Next market share in clothing & footwear online (JPMC estimate)
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Minimal growth expected in Next core customer demographic In contrast to peers that are targeting the older market, growth in Nexts target population size is expected to be more subdued. The size of the female population aged 25-44 years old in England is expected to grow by 4.1% in the ten years to 2021 (source, ONS) representing a CAGR of only 0.4%.
Nexts demographic trends are unfavourable to future growth
If we assume that Nexts demographic ages with the current customer base as is typical for a clothing retailer it is also necessary to consider trends in the 35-55 year old ages group. These are marginally more negative for Next with the ONS forecasting a cumulative decline over 10 years of -2.1% representing a CAGR of 0.2%. This is in contrast to the female population of over 65 year olds which is forecast to grow by 19.5% or a CAGR of 1.8% per annum, which is beneficial for M&S. A similar contrast can be seen in expectations for the male population. The number of men aged over 65 is expected to grow by 26.3% over the 10 year period compared to growth of only 8% for men aged between 25 and 44 years old (flat for 35-55 year olds).
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So where, in a difficult consumer market, is this growth in Directory customers coming from? Without access to each customers personal details, it is naturally difficult to say definitively, but unsurprisingly our analysis of Nexts online market share and Directory share would seem to suggest that they are primarily coming from the Next Retail store base rather than representing incremental consumers. This is, we believe, undoubtedly the case when we think about the growth in the context both of Next's over-penetration online and of the recent boost provided by the switch to cash with order, which has tempted those "hold-out Next Retail customers who did not like having to order on credit.
Figure 19: Next Online share change vs Next Directory share change (2009 on 2005)
M&S Next Retail House of Fraser Matalan Bonmarche John Lewis Debenhams Sports Direct Next Directory H&M N Brown River Island Arcadia Group Asda New Look Peacocks Tesco TK Maxx Shop Direct Sainsbury Primark -1.00% -0.50% 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00%
Source: Verdict
That online is cannibalising store sales is not new news. For some years now the debate in retail has been around the transfer of sales from physical space to online and the impact that could potentially have on store metrics. Nowhere within clothing is that effect more marked than at Next, which has the most developed online business of any of the major apparel players. Directory now represents 31% of Group sales and is more than half the size of Retail and is cannibalising the store base. Yet investors do not seem to be concerned by this trend, if the share price is any judge, and they have been right not to be over the last few years as the company has maintained profitability in the face of challenging economic conditions. However, we argue that this trend is unsustainable in the longer-term and there will inevitably be a point at which the metrics within the store base will move the wrong way.
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Underlying cost efficiencies have been unable to keep pace with falling sales Brand sales densities have been falling since 2003, decreasing by 44% in total from 953 to 533 in 2012. This has been partially mitigated by an improving gross margin with COGS falling by 50% on a square foot basis over the period. However, despite aggressive efficiencies in underlying costs, the decline in opex per square foot has been unable to fully keep pace with the Brand LFL sales decline (we estimate -1% on average over the eight years to 2012) resulting in an overall fall in Brand EBIT per square foot of 28% from 130 in 2003 to 93 in 2012. This begs the question as to what happens when sales per square foot approach the point at which profit begins to move backwards. We explore this further in our scenario analysis
Figure 21: Retail EBIT per sq ft
120 100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Retail EBIT per sq ft
Source: J.P. Morgan estimates Company data.
Rent % sales
Source: J.P. Morgan estimates Company data. NB Next sales include Directory
Staff % sales
Source: J.P. Morgan estimates, Company data. NB staff costs for Next include Directory staff costs and Directory sales
Next has reduced staff per 000 sq ft by 50% over the last 7 years
Focusing on staff as % sales ignores the already efficient nature of Nexts staffing While Nexts staff costs are high relative to peers (Figure 24), it has been making considerable efficiencies over time (Figure 25), which have allowed it to maintain its staff cost ratios at a fairly constant level of sales despite sales densities halving. This has been achieved through improved scheduling amongst other things, which has allowed Next to reduce staff intensity per 000 sq ft by 50% over the last seven years. Management argues that staffing densities are an irrelevant measure as the most important metric to focus on is staff costs as a % of sales, as it is throughput of product per staff member that matters, not intensity of staff on the shop floor. While we can see some validity to this argument, we would, however, suggest that having a lower staffing ratio per 000 sq ft than peers may well mean that customers compare their ability to find a staff member when they want one unfavourably across retailers.
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Management argues that the most important metric to focus on is staff costs as a % of sales as it is throughput of product per staff member that matters, not intensity on the shop floor
But the already efficient staff base in our view shows that the scope to make more efficiencies is limited
More importantly the already low level of staffing means in our view that the scope to make further efficiencies in this area is limited.
Figure 25: Brand staff costs ratios have improved over time
20.0% 19.5% 19.0% 18.5% 18.0% 17.5% 17.0% 16.5% 16.0% 2004 2005 2006 2007 2008 2009 2010 2011 Staff costs as % of sales 160 140 120 100 80 60 40 20 0 2001 2003 2005 2007 2009 2011
Brand staff costs per sq ft
Source: J.P. Morgan estimates, Company data. NB this includes Directory staff, store staff per 000 sq ft is even lower
Furthermore, we would note that the above ratios are based on Brand staffing numbers (ie inclusive of Directory) and that Retail FTEs could now be as low as just over 3 per 000 square foot (down from over 7 in 2001) highlighting that whilst cost efficiencies have been aggressive, there is little scope for further savings. If we are correct in our estimate it would also imply store staffing levels only marginally above New Look (2.2 per 000 sq ft) which is well known for its focus on value ahead of customer service.
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Cash customers spend less on average In the first 2 years following the start of the downturn, sales per customer were relatively flat at 370 in 2008 and 371 in 2009. In 2010 sales per active customer fell by 5% to 352. This was driven by the introduction of cash with order where customer spend is significantly lower in part because they order less in value terms per order and in part because they order much less frequently. Whilst the differential has reduced it remains significant, we estimate in the region of 42% (spend in store is c.third of average Directory account customer spend and hence a differential in cash versus credit spend in the region of 30% to 45% seems reasonable). In 2012 sales per customer grew by 6% to 364 per customer (albeit remaining below 2007 levels of 374). The increase is explained at least in part by an improved service offering in the year, and in particular the introduction of next day delivery as standard for orders before 9pm. However, it is not clear if the groups initiatives generated incremental Brand sales, or rather encouraged an acceleration in the shift to Directory, with falling sales densities at a Brand level being supportive of the latter. Furthermore, the impact of the introduction of next day delivery clearly shows the impact of the service offering on customer behavior, highlighting the importance of being at least in line with peers on service with regards to delivery and returns. Increasing proportion of cash customers will generate further margin dilution Cash with order customers currently account for 14.6% of the Directory customer base but account for a lower proportion of sales (we estimate c.9%) due to a lower average spend (we estimate spend by cash customers is c.42% lower on average).
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We believe increased convenience of the service proposition stimulated the transfer of Retail customers to Directory
We estimate that every 10% shift towards cash customers costs c. 800bps of margin
Account customers are more profitable as a result of the service income they generate, effectively the interest income (25.99% APR) and charges on the credit provided by Next, less the bad debt charge. Between 2007 and 2009 (before the introduction on cash with order) the average benefit to the Directory margin as a result of the net service income was 8.3%, implying that account customers are more profitable than cash with order customers. This has been confirmed by management. Since the introduction of cash with order in 2010, Next has lost up to 180bp of margin. Whilst this was in part due to customers paying more quickly (in order not to incur interest and charges that they could ill afford given the difficult macro), we estimate that at the very least, every incremental 10% penetration of cash with order customers will have a dilutive impact on the Directory margin of c.80-90bps. Going forward we expect the growth in cash customers to continue to outpace account customers (account customers +12% in the 2 years to 2012 versus cash customers +196%) as Retail customers who have traditionally paid by cash and have been reluctant to open an account migrate sales online. Since 2010 cash customers have grown by 8.5% as a proportion of the total Directory customer base to 14.6% and management believes this could comfortably rise to 20% within the next 2 years. The trajectory to date suggests that this forecast could be conservative (and management accepts that in the long term cash penetration could be substantially higher, although it does not necessarily think it will be). Merely taking the 20% number given by management would imply an incremental 5.4% penetration, which would impact the Directory margin by c.40bps to 50bps.
Figure 27: Service income as % of Directory sales
14% 12% 10% 8% 6% 4% 2% 0% 2005 2006 2007 2008 2009 2010 2011 2012 Serv ice income as % of sales
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We estimate that free delivery would negatively impact Directory margin by 900bp
Free delivery negative impact of 900bp on Directory margin At present Next charges for c. 85% of deliveries. The standard charge is in the region of 3.99 per order/ parcel. However, management does not disclose enough detail for us to calculate the number of order/ parcels shipped to customers per annum and hence we attempt to estimate this based on a number of assumptions. We use the following information in our calculations: 20% of Directory sales are collected in store (company disclosed that 20% of Directory parcels are collected in store at the FY12 results). 15% of the Directory sales delivered by courier are already free (Next commented at the FY12 interim results that 20% of Delivery was effectively free and although management noted at the FY results that this had reduced, we use 15% as our best estimate). There are 3 million Directory customers (as disclosed by Next at the FY results). This implies an average annual spend per customer in 2012 of 721 including VAT and grossed up for returns (excluding both returns and VAT average annual spend is 364). We estimate a Directory returns rate of 41% (calculated from disclosure in the FY12 results and supported by managements comments that Directory returns are in the high thirties). We assume that the average standard delivery charge for paid for orders is 3.99 as per the website (this charge appears to be applied to all orders as standard regardless of product category or value). We assume an average order value (inc VAT) of 100, implying an average order frequency of 7 times per annum. This is in line with managements comments that account customers order over 100 of product 2-3 times a season (2 main
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season and 2 mid season books per annum). Cash customers order both less often and a lower value on average. The above assumptions imply that in FY12 Next generated income of 59m through charging customers for delivery (Figure 28). A move to 100% free delivery would therefore represent a c.500bps impact on the Directory margin and a c.10.3% impact to group PBT.
Figure 28: Impact on group PBT if existing paid for sales were free delivery
Directory sales inc VAT and grossed up for returns Collected in store (inc VAT) Delivered by courier Sales delivered by courier with free delivery Sales where delivery charge paid by the customer Directory customers (m) Average spend per customer pa Average order value Implied average order frequency pa Implied no. of parcels (m) pa - total Implied no. of parcels (m) pa - delivery paid by customer Standard delivery charge Current income generated from customer delivery charge
Source: J.P. Morgan estimates, Company data.
2160m 432m 1728m 259m 1469m 3.0 721 100 7x 22 15 3.99 59m
Free delivery could increase average order frequency with an incremental negative impact on the margin A delivery charge encourages customers to bundle orders (Next appears to currently charge 3.99 for delivery regardless of the number of items/ value of order). A move to free delivery is therefore likely to encourage customers to disaggregate orders.
Free delivery is highly likely to drive down basket size and increase frequency and hence cost
Based on feedback from a number of private retailers we understand the cost per parcel charged by the courier to be in the region of 2.50 to 3.00. We would expect, given Nexts scale and dominant position with respect to its courier company, that the courier cost to Next is at the bottom end of this range or a little below. Asos (already offering free delivery) and N Brown (standard delivery charge is 25% cheaper than Next at 2.99) have an average basket/ order value of 64 and 73 respectively. If the introduction of free delivery caused the average Next Directory order size to reduce from 100 to 73 (but frequency increased by 1.4 times, with sales therefore remaining flat), the number of parcels per annum would increase by 37% with an incremental cost in the range of c.16m (assuming a courier cost of 2.00 per parcel). This would have a 2.8% impact on group PBT in addition to the initial impact discussed above (Figure 28). Alternatively if the average order size were to fall as low as 64 in line with Asos, we estimate that Next would bear an incremental cost of c.24m equating to a 4.3% impact on group PBT (Figure 30).
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Figure 29: Increase in avg order frequency (avg order value falls to 73) Average order value falls to: Avg order frequency pa on orders prvs paid for by the customer Implied no. of parcels (m) pa - delivery paid by customer Incremental parcels pa
Undisclosed private retailer pays 2.50-3.00 per parcel to be delivered Cost per parcel: 1.50 2.00 2.50 3.00
Source: J.P. Morgan estimates, Company data.
73 10x 30 8
Figure 30: Increase in avg order frequency (avg order value falls to 64) Average order value falls to: Avg order frequency pa on orders prvs paid for by the customer Implied no. of parcels (m) pa - delivery paid by customer Incremental parcels pa
Undisclosed private retailer pays 2.50-3.00 per parcel to be delivered Cost per parcel: 1.50 2.00 2.50 3.00
Source: J.P. Morgan estimates, Company data.
64 11x 34 12
Free delivery could also generate an incremental channel shift; increasing the cost base while Brand sales remain flat The second most common reason for customers abandoning their online shopping baskets is cost of delivery is too high (source, Forrester and Royal Mail). The removal of this deterrent could therefore act to encourage Next Retail customers to transfer their spend online. Assuming no store closures/ reduction in store costs, this would simply add incremental costs without any additional sales. The impact on profit is dependent on the average order size and we consider the range of outcomes below (Figure 31). Assuming an average order size of 33 (lower than discussed above given that it is a transfer in spend from Retail where the average spend is around a third of that of Directory account customer) and a delivery cost to Next of 2.00 implies that every 1% of sales that are transferred from store would impact group profit by 1.6m (or a 0.3% impact to group profit). The introduction of free delivery as standard would likely accelerate cannibalisation of the UK store base in our view. For FY13E management is guiding for a LFL Retail sales decline of -4% to -7% or 88m to 153m lost sales. Its guidance on Directory is high single digit growth (+9% would imply 98m of sales), suggesting that it expects a significant element of the Directory growth to represent cannibalisation of the store sales. If we conservatively assume this trend continues at
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the lower end of the range (that is, 4% of Retail sales shift into Directory per annum) and that these sales are free delivery this implies a c.1.2% negative impact on group profit per annum (that is 4x the 0.3% impact discussed above). Over 3 years therefore this would reduce PBT in the region of 3.6%.
Figure 31: Impact if sales are transferred from Retail to Directory Retail sales 1% transfer of Retail sales (ex VAT) 1% transfer of Retail sales (inc VAT)
Avg order size Implied no. of parcels (m) Undisclosed retailer pays 2.50 to 3.00 per parcel 1.50 2.00 2.50 3.00
Source: J.P. Morgan estimates, Company data.
Free shipping is expected to cost Asos c.13% of sales in FY13E, up from zero in 2008
Experience of Asos highlights risk of margin dilution All of this, of course is theoretical, but we do have a real life example to look at in Asos, which has been a leader relative to other UK retailers in developing its service offering to consumers. Both delivery and returns are now free for UK customers. Initially both delivery and returns were charged for and Asos formally moved to free delivery in the UK in April 2010. However, in the years prior to this it had been increasingly moving towards this point with an increasing number of promotional free delivery offers. Over this period the group moved from making a small profit on delivery receipts of 1.9m in 2008, to a loss of 21.9m in 2011, representing an impact on the group operating margin of 9.5% (marginally inflated by the impact of free global shipping in one quarter of 2011). In 2013 this is expected to move to a loss of 85m on a sales base of 676m (this compares to Next Directorys sales of 1.1bn), representing 13% of sales. This gives some context to our assumptions above and provides us with some comfort on the assumptions. Free returns is much less significant - 94% of returns are free already The Directory business has a returns rate in the high 30s. Customers make 59% of their returns through stores at no tangible delivery cost to Next (whilst there is a cost of processing a return in store, a processing cost would also have been incurred had the goods been returned directly to the warehouse and this is therefore simply an allocation issue in our view). Returns are free for Next cardholders and therefore we estimate that Next already incurs the delivery charge for a further 35% of returns. This leaves only 6% of returns where the cost is currently incurred by the customer. Assuming a cost of c.2.00-2.50 to Next per parcel and an average return value of 41 (given the 41% returns rate and assumed average order value of 100) would imply a c.0.4% impact to group earnings if free returns were implemented. Given that 85% of the Directory customer base (that is, account customers) are already eligible for free returns, we would not anticipate a significant change in the
Free returns are not expected to have a significant impact as virtually all returns are already free.
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percentage going through store if a blanket free returns policy was introduced and hence we would not expect the impact to be material. Given the high proportion of free returns already in place, we would not expect a move to free delivery/ returns to significantly change the returns rate. Reduced production and print costs could partially offset the impact but high risk Despite customers paying c.4 for a Next Directory, each book costs the company c.12 to produce and deliver, generating a loss therefore of around 8 per book. Each year there are 4 editions of the catalogue (Christmas, Autumn/Winter, Spring/ Summer and Summer). Of the almost 3 million Directory customers we assume 2.3m buy a copy of the book, implying a maximum cost, and therefore maximum potential saving, in the region of 72m, representing 12.6% of PBT. However, there are two reasons why any potential saving is likely to be some way below this level. Firstly there are costs associated with the production of the Directory that would continue to be incurred regardless of the size of the print run (all the photography for example is also necessary for displaying the product on the website). We estimate that the delivery cost is c.4 of the full 12 cost per book. In 2000 we estimate that print costs were c.4.20 per book (based on active customer numbers and disclosure that print costs represented 6% of Directory sales at the time). Given the threefold increase in customers since then we would expect the current print cost per book to be at a lower level. However, this implies current photography costs in the region of 36m (ie c. 50% of the total cost) and therefore a maximum potential saving of 36m (representing 6.3% of PBT). Secondly, whilst the number of catalogues is likely to decline over time as Next customers become increasingly comfortable with using the internet to browse rather than simply to order, at present management view it as a key sales driver and there is therefore a risk that any sharp deterioration in catalogue distribution could negatively impact the top line to a significant degree.
We estimate the Big Book production and print costs are c.12.6% of PBT annually
In addition, the adverse impact on sales of withdrawal of the Big Book would be in our view significant
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We believe that a move towards free delivery would be driven only by a defensive motivation. Management is adamant that free delivery will not become standard, because "it would cost retailers too much. We are skeptical with respect to this assumption given the force of customer behaviour in changing internet dynamics to date and given the increased use of free delivery as a promotional tool by both physical and online peers, we see free delivery as standard in the market as inevitable in time. Table 4 compares current delivery pricing across the market, but we would make the following comments: Next has the best service proposition in terms of speed of delivery, which we believe has been a key advantage in terms of driving customer loyalty, but which leaves little room for manouevre in a customer service war While many of these retailers appear to charge for delivery, in reality several offer so many free delivery promotions that delivery is effectively free for most customers (many at the time of writing were offering free delivery codes over order thresholds) This offer has already evolved considerably in other segments of retail, where free delivery is effectively standard
There is scope to build some of the cost into the price of the garments, but only we believe if everyone were to adopt the same approach
Management at Next has also indicated that while it does not believe free delivery to be standard, if it were to become so then the cost would be built into the price of the product. However, this seems difficult to envisage as the impact on Next would be considerably greater than for peers with lower online penetration, which would imply a disproportionate pricing shift for it vs the peer group, which in turn would adversely impact market share. In addition, given the need to maintain price parity between stores and online, prices in store would also need to rise, perhaps by a significant amount if average order values fell post the introduction of free shipping. In addition, such an approach would rely on competitors "holding the line" on their own pricing and delivery propositions and given the competitive nature of the market, that seems unlikely.
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Free
Standard Cost & Speed 3.95. Within 3 working days Free. 2-4 working days 3.99. Next Day
3.50. Up to working 5 days 3.90. Within 4-6 working days 3.95. Within 3-5 working days 3.00. Within 4 working days 4.50. Within 2-5 working days 3.00. Within 3-5 working days 3.95. Within 5-7 working days 3.95. Next Day 3.99. Within 4 working days 2.99. Within 5 working days 4.00. Within 2-4 working days 3.95. Within 3 to 5 working days On orders over 75 On orders over 55 On orders over 50 On orders over 30
It is possible that free delivery could drive incremental sales. This has been the case with Asos but we would argue that it had a first mover advantage as well as no significant incumbent store base to cannibalise. Furthermore, Next already has significant penetration of its customer profile base (ABCD1 women in the 25-44 year old age bracket). Assuming that the majority of the almost 3 million Directory customers are women implies 41% penetration in this age bracket alone (7.2 million, 25-44 year old women in the UK, source ONS), and in practice will be higher than this given that the Next demographic is focused on ABC1s. Furthermore this excludes any Next Retail customers that do not shop through Directory. This implies an even higher penetration in their core customer demographic. Hence, in our view, incremental Next Brand customer growth in the UK is unlikely from here and we would not expect to see a material impact on Brand sales as a result of free delivery.
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FY13E Guidance
Managements guidance for FY13E is outlined in Table 6: .
Table 6: Management guidance for H1 and FY 2013
Low-scenario H1 guidance LFL Retail sales Total Retail sales Directory sales Brand sales FY13 guidance Brand sales PBT PBT growth Buyback (% of shares) EPS growth
Source: Company reports.
High scenario -4% 0% +12% +4% +4% 610m +7% +4% +12%
Total Brand sales are expected to increase by +1% to +4% with high single digit growth expected from Directory (H1 guidance is +9% to +12%). Assuming 9% growth for Directory, would imply a FY change in Retail sales of between +1% and 3% (H1 guidance is 0 to -3%), which given an expected space contribution of 4% (60% conversion) implies an expected LFL of between -3% and -7%. Bought in gross margins are expected to be flat with manufacturing costs and selling prices level yoy. No significant changes to markdown are expected; hence, gross margins are expected to remain flat. Annual LFL inflation in the cost base is expected to be 36m driven by wage inflation of 2.5% and underlying increases in rent and rates. Management expects to offset 28m of this cost pressure with cost savings. Management has also indicated that we should expect a 28m interest charge, 8m of profit from international and 25m of profit from sourcing. Implementing managements guidance, results in a modest upgrade to our PBT estimate for FY13E from 545m to 561m. This puts us at the bottom of the range of guidance and 5% below BBG consensus of 590m. This appears to be primarily due to our assumptions on margin as we are only 1% below BBG consensus on sales. These assumptions are discussed in more depth below.
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FY13E assumptions
Q1 likely to be difficult Next is due to report its Q1 IMS on 2 May. We expect LFL Retail sales to have declined by 9% which, while a deterioration on a headline basis (Q4 FY12 -3.2%), represents a broad maintenance of the underlying run-rate on a comparative that is c.650bps tougher. In line with managements FY guidance we expect a contribution from new space in the region of +4% resulting in a decline in total Retail sales of 5% (expected new space contribution to total Brand sales +2.7%). In the Directory business we also assume that the underlying trend continues (2-year growth rate +26%) implying Q1 sales +11% yoy. Retail sales data and commentary for Q1 has to date been marginally more positive than over the last 6 months. John Lewis has reported strong performances with fashion being up mid to high single digit on average. M&S sales, whilst disappointing, were the result of the group under potentialising and M&S data actually suggested that the consumer environment was stable to marginally more positive. The warm weather in March also provided a boost. Overall therefore it appears that underlying trends in the consumer environment are largely unchanged since Next released its FY results in mid-March and as such we do not expect any material changes to FY guidance (JPMCe FY13E PBT c. 5% below consensus). FY sales growth bolstered by strong Directory Within the Retail business we expect square footage to grow by c.6% in FY13 and contribute 4% to top line growth (60% conversion), in line with the guidance. At this stage management expects around half of the space to be in standalone home stores. We forecast a FY13 LFL of -5.5% at the mid-point of the implied guided range (-4% to -7%). Overall therefore we expect sales in the Retail business to decline by -1.5%. We expect Directory growth to continue to be impressive at +9% (guidance is for high single digit growth) driven by in part by the ongoing annualisation of the offers tab and in the main by a continued shift in spend from Retail, through both growth in cash customers and an increase in account customer spending online rather than via cash in store. In line with management guidance we also assume an incremental 20m from international online sales (taking the total to 50m) which contributes 1.8% to total Directory growth of +9%. Overall therefore this implies total growth in Brand sales of +2%, within the range of management guidance of +1% to +4%. We would note however, that given the new space contribution, this implies a negative underlying Brand LFL of -0.7% (or -1.3% excluding international online). FY margin in both businesses under pressure We assume that the gross margin in both divisions remains flat yoy given no material change expected by management in bought in gross margin or the level of markdown yoy. We expect the Retail EBIT margin to decline by 100bps yoy (discussed in detail below) which, combined with the negative top line performance, results in EBIT of 297m, a yoy decline of 8.2%. We expect Directory EBIT margin to fall by 60bps yoy (discussed in detail below), generating growth of only 6.2% yoy in Directory profits (despite the more impressive top line performance).
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We model international and sourcing profit and interest in line with guidance as detailed above. Combined with a share option charge of 17m (flat yoy) we expect PBT of 561m, a decline of -1.6% yoy, at the bottom of the guided range of -2% to +7%.
FY14E assumptions
Sales trend unchanged in Retail, but Directory slows to +5% In FY14E we expect top line trends within the Retail division to remain broadly unchanged with space growth of +4.3% and Retail LFL of -6% resulting in an overall decline in Retail sales of -1.7%. However, we anticipate that the extent of mitigation caused to the overall decline in Brand sales reduces as the rate of Directory growth slows. We forecast Directory growth of only 5% in FY14, implying LFL Brand sales of -2.1% (total Brand sales +0.6%). Pressure persists on margin We have little visibility on gross margins out to CY13, however, we see little reason for the sourcing environment to move in the retailers favour (with Chinese wages for example continuing to experience double digit increases). With any improvement in the aggressively promotional environment that currently persists likely to be offset, we assume gross margins remain flat. We assume a continued decline in both the Retail and Directory EBIT margins, by 110bps and 60bps respectively (discussed in more detail below). With the other largest elements of PBT (share option charge and interest) being unchanged yoy this results in FY14E PBT of 542m (-3.5% yoy).
FY15E assumptions
We expect sales trends in both the Retail and Directory business to be unchanged versus FY14 with Retail sales falling by 2% in total (space +4% and LFL -6%) and Directory growth of +5%. This results in total Brand sales rising by only +0.6% and a negative Brand LFL of -1.9%. In line with FY14 at this stage we assume flat gross margins in both divisions in FY15 and that the EBIT margin will fall by 130bps and 50bps in Retail and Directory respectively. With the share option and interest charge remaining unchanged yoy we forecast FY15E PBT of 521m, a yoy decline of -3.8%.
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2009 2197.2 -7.1% 4.5% -2.6% 288.6 13.1% 816.4 2.1% 157.6 19.3% 3088.1 428.5 50.4% -14.0% 155.7 -6.6%
2010 2274.2 0.3% 3.2% 3.5% 324.0 14.2% 873.2 7.0% 183.6 21.0% 3215.1 505.3 51.3% 17.9% 175.9 13.0%
2011 2222.1 -4.0% 3.0% -1.0% 328.8 14.8% 935.5 7.1% 221.9 23.7% 3229.0 551.4 52.0% 9.1% 206.4 17.3%
2012 2191.4 -5.7% 4.3% -1.4% 323.7 14.8% 1088.7 16.4% 262.6 24.1% 3363.9 570.3 52.5% 3.4% 237.0 14.8%
2013E 2158.5 -5.5% 4.0% -1.5% 297.2 13.8% 1186.7 9.0% 278.9 23.5% 3433.0 561.3 52.4% -1.6% 246.4 4.0% 589.1 -4.7% 265.7 -7.2%
2014E 2120.9 -6.0% 4.3% -1.7% 268.1 12.6% 1246.0 5.0% 285.3 22.9% 3458.3 541.8 52.3% -3.5% 247.8 0.6% 617.0 -12.2% 292.2 -15.2%
2015E 2078.3 -6.0% 4.0% -2.0% 236.2 11.4% 1308.3 5.0% 293.1 22.4% 3481.6 521.2 52.3% -3.8% 248.3 0.2% 654.7 -20.4% 322.3 -23.0%
2009 439.9 -39.8 400.1 -134.4 -106.5 -51.3 107.9 -740.5 4 -628.6
2010 491.5 46.8 538.3 -96.2 -108.5 -107.3 226.3 -628.6 2.1 -400.1
2011 507.9 -76.6 431.3 -138.1 -129.6 -290.3 -126.7 -400.1 -3.6 -530.4
2012E 576.2 -69.2 507 -70.2 -135.1 -330.2 -28.5 -530.4 -15.8 -574.7
2013E 556.3 -56.1 500.1 -115 -140.8 -240 4.3 -574.7 0 -570.4
2014E 541.7 -13.7 528 -115 -146.8 -240 26.2 -570.4 0 -544.3
2015E 526.2 -13.8 512.3 -115 -153 -240 4.3 -544.3 0 -540
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FY2009 612.8 55.4 4.5 14.1 0.0 687 318.7 524.4 199.6 47.8 1091 1777 121.3 204.8 1281 1607 13.1 156.6 1777
FY2010 577.2 47.4 5 22.7 0.0 652 309 529.9 95.3 107 1041 1694 4.7 175.0 1367 1546 13.4 133.4 1693
FY2011 592.4 46.5 5.1 81.0 0.0 725 368.3 558.9 90.8 49.3 1067 1792 10.2 195.5 1341 1547 13.3 232.5 1792
FY2012E 581.9 45.6 6.1 80.7 0.0 714 371.9 612.4 99.2 56.4 1140 1854 7.6 223.7 1388 1619 12.0 222.7 1854
FY2013E 576.9 45.6 6.1 82.2 0.0 711 381.1 624.5 99.2 66.3 1171 1882 7.6 188.8 1405 1601 12.0 268.4 1882
FY2014E 571.9 45.6 6.1 83.7 0.0 707 383.9 636.7 99.2 97.9 1218 1925 7.6 190.2 1422 1619 12.0 293.4 1925
FY2015E 566.9 45.6 6.1 85.2 0.0 704 386.5 649.3 99.2 107.4 1242 1946 7.6 191.5 1438 1637 12.0 296.5 1946
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Going forward therefore we expect gross margins to remain flat across both divisions. Negative operational gearing has impacted cost metrics Whilst Next has performed well historically on cost control, the decline in top line in the Retail division has nevertheless resulted in a cumulative deterioration in the opex ratio of 700bps in total over the 6 years. The key driver of this has been occupancy costs which have negatively impacted the EBIT margin by 570bps over the period in total (or 100bps pa on average). This is unsurprising in view of the limited scope for savings in this area given the upward only nature of UK lease agreements and the negative operational gearing of a declining retail sales base. We expect this trend to continue The second key driver of the decline has been central overheads which have contributed 80bps to the decline in the margin in total given their relatively fixed nature. Perhaps surprisingly given the aggressive efficiencies that Next appears to have made in staffing, store payroll costs have also had a negative impact of -20bps over the period Up until FY11, distribution and warehouse expenses have remained flat as a proportion of Retail sales which is unsurprising given their largely variable nature. However, in FY 2012 they started to have a detrimental effect on the margin (-30bps), we assume in part due to the deterioration in the top line and in part due to increased handling costs in store on the behalf of the Retail business We expect the cost ratio to continue to deteriorate In the Retail business, as LFL sales remain in negative territory we expect the cost ratio to continue to deteriorate over time driven by the impact of negative operational gearing, and we forecast a cumulative fall of 340bps over the 3 years to 2015 (100bps in FY13 and -120bps in both FY14 and FY15). Negative operational gearing on occupancy costs is a key factor The biggest contributor to the forecast decline is occupancy costs (both rent and utilities). The group has been experiencing rental inflation across the portfolio of c.+1% to +1.5% on average in recent years and we expect at least this rate of increase going forward. Whilst we expect Next to continue to negotiate aggressively with landlords (particularly in less desirable locations when a lease is up for renewal), with upward only rent reviews in place there is little opportunity to mitigate rental costs without a reduction in the size of the portfolio which is something that management has confirmed it is not considering. Implicit in our margin assumption is therefore an annual decline 60-80bps from store occupancy costs versus a historic average of -100bps pa. We assume that central overheads are already at very efficient levels and hence as sales deteriorate, these increase by 30bps as a percentage of the top line per annum (in line with the deterioration in 2012). We see downside risk to our occupancy cost assumptions. Given the variable nature of staff costs we assume that the ratio of staff payroll costs to sales remains constant yoy going forward. However, as discussed in some detail in earlier sections, Next
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already appears to have one of the lowest number of FTE staff per 000 square foot versus peers which therefore begs the question whether further efficiencies in these costs can actually be achieved without a significant impact on current customer service levels. We therefore consider this assumption to be relatively generous (particularly given a negative impact on the ratio of 20bps over the past 6 years when cost savings in this area were ongoing) and see the potential for downside risk to the margin as a result. We assume warehousing and distribution costs should also continue to deteriorate Despite the variable nature of distribution and warehouse costs in theory, we assume that there is a minimum level of costs which is effectively fixed (delivery costs to stores, fixed element of the warehouse costs attributable to Retail etc) and therefore assume some negative operational gearing in this element of the margin going forward of -40bps on a cumulative basis over the 3 years to FY15 (relatively generous versus a -30bps impact in FY12).
Table 10: Retail Margin Breakdown
RETAIL MARGIN BREAKDOWN Starting margin Increase in achieved gross margin Change in bought gross margin Reduction in markdown Provisions and Slippage Increase in store occupancy costs Reduction in store payroll costs Increase in central overheads Increase in distribution and warehouse costs Change in cost ratios Closing operating margin 2007 2008 14.8% 1.5% 1.6% -0.1% 0.0% -1.9% -0.4% 0.0% 0.0% -2.3% 14.0% 2009 2010 13.1% 1.0% -0.4% 1.4% 0.0% 0.3% 0.0% -0.2% 0.0% 0.1% 14.2% 2011 14.2% 0.6% 1.0% -0.4% 0.0% -0.6% 0.0% 0.6% 0.0% 0.0% 14.8% 2012 14.8% 0.7% 0.3% 0.4% 0.0% -0.4% 0.3% -0.3% -0.3% -0.7% 14.8% 2013E 14.8% 0.0% 0.0% 0.0% 0.0% -0.6% 0.0% -0.3% -0.1% -1.0% 13.8% 2014E 13.8% 0.0% 0.0% 0.0% 0.0% -0.7% 0.0% -0.3% -0.2% -1.2% 12.6% 2015E 12.6% 0.0% 0.0% 0.0% 0.0% -0.8% 0.0% -0.3% -0.1% -1.2% 11.4%
14.0% 14.2% 1.8% 1.4% 1.4% -0.1% 0.0% 1.6% 0.0% -0.1% -1.0% -2.1% -0.2% 0.1% -0.4% -0.5% 0.0% 0.0% -1.6% -2.5% 14.2% 13.1%
Directory operating margin breakdown The improvement to the Directory margin as a result of opex movements over the 5 years to FY12 has been impressive at +820bps on a cumulative basis. The key drivers have been: The warehouse and distribution element which has contributed 420bps to the improvement. However, we would note that the majority of this was in 2007 (+330bps when Next opened its new boxed warehouse) and the trend has been negative in the last two years (-80bp in FY11 and -70bp in FY12). Perhaps generously given the trend of the last 2 years, we have assumed that this cost ratio declines by 50bp pa over the next three years. A significant reduction in the bad debt charge (+480bps). However, this was weighted towards 2008 when we saw an improvement of 270bps as management tightened up credit terms during the credit crunch. Management said recently that bad debts were at record low levels, hence we believe there is little scope to reduce this further, although in theory it should fall as the proportion of account customers in the mix declines we have assumed a 40bp annual benefit to Directory margin from a reduction in bad debt ratio. The benefit to margin from a falling bad debt ratio due to cash customer growth will be offset by a commensurate decline in service income. The adverse fall in this ratio has been 80bp over the last five years, but this has accelerated to 32
100bps in FY11 and FY12 post the introduction of cash customers. We expect this trend to continue. . We expect positive operational gearing effects as the top line continues to grow and hence are assuming central overheads fall as a percentage of Directory sales by 50bps pa. Overall we are assuming that Directory margin deteriorates by 170bps on a cumulative basis over the 3 years to FY15 with the key driver of this decline a fall in the proportion of service charge income (net of bad debts). We expect a significant proportion of growth in the Directory top line to be driven by an increase in less profitable cash customers (and estimate that every incremental 10% penetration in cash sales has a c.80bps impact on the Directory margin). We therefore assume that a 60bps pa decline in the Directory margin in the 3 years to FY15.
Table 11: Directory Margin Breakdown
DIRECTORY OPERATING MARGIN Starting margin Increase achieved in gross margin Change in bought in gross margin Reduction in markdown Other provisions Decrease in bad debt Increase in service charge income Warehouse and distribution Decrease (Increase) in central overheads Other factors Closing margin 2007 14.1% -0.2% 1.2% -0.2% 0.0% -0.6% 1.5% 3.3% 0.5% 0.0% 18.6% 2008 18.6% 0.1% 0.8% -0.5% -0.2% 2.7% 0.4% 0.7% -1.9% 0.0% 20.6% 2009 20.6% -1.2% -0.9% -0.3% 0.0% 0.0% 0.2% -0.3% 0.0% 0.0% 19.3% 2010 19.3% 0.5% -0.4% 0.9% 0.0% 0.7% -0.3% 1.0% -0.2% 0.0% 21.0% 2011 21.0% 1.3% 1.3% 0.0% 0.0% 0.6% -0.6% 1.0% 0.4% 0.0% 23.7% 2012 23.7% 0.8% 0.6% 0.2% 0.0% 0.4% -0.9% -0.7% 0.8% 0.0% 24.1% 2013E 24.1% 0.0% 0.0% 0.0% 0.0% 0.4% -1.0% -0.5% 0.5% 0.0% 23.5% 2014E 23.5% 0.0% 0.0% 0.0% 0.0% 0.4% -1.0% -0.5% 0.5% 0.0% 22.9% 2015E 22.9% 0.0% 0.0% 0.0% 0.0% 0.4% -1.0% -0.4% 0.5% 0.0% 22.4%
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The cash generative nature of the group has also allowed it to consistently buyback shares. In FY11 and FY12 it purchased 222m and 291m of shares respectively, contributing 7.5% to EPS growth in FY11 and 6% in FY12. Going forward we forecast buybacks of 200m pa out to FY15 (FY13 guidance is for between 140m and 200m). This level of buyback, combined with the dividend is fully covered by FCF out to 2015 (average FCF cover over the period of 1.0x versus 0.8x in FY12). However, ultimately we would expect to see a convergence in the P&L and cashflow over the longer term and hence 10% growth in the dividend, combined with a substantial buyback, is not sustainable on a long term basis if profits deteriorate. In line with our assumption that the majority of FCF going forward is returned to shareholders (through a combination of dividend payments and buybacks) we therefore expect a relatively small reduction in net debt over the 3 years to FY15 of 51m to 524m (from 575m in FY12). In this scenario the net debt/ EBITDA ratio remains comfortable at c.0.8x over the period (in line with FY12 levels). Debt facilities robust In FY12 Next renewed its medium term bank facilities (supported by a syndicate of 6 banks) and issued a new 10 year 325m bond (as well as buying back 158m existing bond debt). The groups current facilities and corporate debt are detailed below: 85m of 2013 bonds 213m of 2016 bonds 325m of 2021 bonds 300 committed bank facilities out to 2016 As is the case with the majority of retailers across our coverage Next has substantial off balance sheet debt in the form of operating leases. We estimate the capitalized leave value to be 633m. However, we would also note freehold property on the balance sheet at a carrying value as at January 2011 of 66m.
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Retail sales were 80% of the total. We treat staff costs as variable in our analysis. We allocate pension costs according to our assumed Brand staff percentage; however, we treat this as a fixed cost. Depreciation. We allocate depreciation according the divisional contribution to Brand sales in the year. Other costs (distribution, marketing and utilities). We attribute the undisclosed remainder of costs to marketing, distribution and utilities. We split marketing costs between both Retail and Directory with the majority being allocated to the latter given the Directory book. We assume distribution costs are in the region of 7% of Brand sales (in line with the variable cost portion of Asos warehouse costs) and we attribute just over half to the Retail business. We assume that utility costs are fixed (given the medium to long term nature of leases in the UK) and that marketing and distribution costs are variable. Service income and bad debt charge. We attribute this to Directory and treat it as variable. We allocate share based payments and central costs (both of which we treat as fixed) according to the annual Brand EBIT contribution from each division.
The base case scenario we have used is based on consensus estimates rather than on our own existing assumptions, as we are already lower than the market and we believe that flexing the consensus case will have a greater impact. We would note, however, that we consider the base case scenario to be a relatively optimistic one, building in a macro recovery. We make the following assumptions in our base case scenario: Retail space growth. We assume space +4% pa to 2017E. Directory top line. FY13E growth of +9% (in line with guidance of high single digit). We assume that the growth rates drops to 7% thereafter and remains steady at 7% out to FY17E. Retail LFL growth LFL Retail sales to decline by -4.1% in FY13E (NB this is at the top of the indicative LFL range implied by management of -4% to -7% and is the main difference between our estimates and consensus (we have -5.5%). We then have a decline of 1.4% in FY14E, +0.7% in FY15E and +3.5% in FY16E This seems an incredibly positive assumption given the track record of the last 5 years in which retail LFL has averaged -4.6%. Gross margin. Remains flat at FY12 levels on a divisional basis. We would note that dependent on the scenario this could generate a small gross margin move at a Brand level (dependent on the relative divisional growth rates given the margin differential). Brand sales growth. The combination of Retail and Directory growth detailed above gives a 5 year CAGR in Brand sales of 5.3% significantly above the historic 5 year average of +1.6%). Store rents. We conservatively assume growth of +1.5% pa in line with the current underlying rate across the portfolio on average plus a further 4% increase pa to reflect the space increase.
36
Retail staff costs. We assume that Retail FTEs per sq ft remain at the 2012 level of 3.0 (JPMC estimate) and that the average annual Retail wage grows by +2.5% in FY13E in line with guidance and then 1.5% thereafter. Directory staff costs. We conservatively assume that Directory staff costs trend down by 10bps pa as a percentage of sales over the 5 years to FY17 driven by some efficiencies as the business continues to transition to internet. Marketing and distribution. We assume that Retail marketing and distribution costs fall by 80bps as a percentage of sales over the next 5 years. We assume that Directory marketing and distribution costs trend down as a percentage of sales by 140bps over the 5 years to FY17 as relative demand for the book reduces somewhat. Depreciation. We assume this grows by 1% in both FY13 and FY14, but remains flat thereafter given the lower capex spend versus historic levels. Pension. We assume this grows by 1% in both FY13 and FY14 but remains flat thereafter. Central costs. We assume growth of 1% pa. Service income and bad debt charge. We assume that this grows at a third of the rate of Directory sales (as new customers are, in the main, Retail customers who have traditionally paid cash with order). We conservatively assume that warehouse rent and share-based payments remain flat in absolute terms. These assumptions result in the following scenario, which gives us PBT in line with the current consensus estimates and a 5 year CAGR in PBT of 6.8% pa. This is significantly ahead of the historic 5 year CAGR in PBT, which was +3.6% (FY20072012).
Table 12: BBG consensus scenario summary
Base case (2013-15E in line with consensus) 2012 Retail LFL -5.7% Implied u/l Brand LFL 0.9% Retail sales (m) 2,191 Directory sales (m) 1,089 Brand sales (m) 3,280 Retail EBIT (m) 323 Directory EBIT (m) 263 Brand EBIT (m) 586 Brand EBIT margin 17.9% PBT (m) 570 5-year CAGR Retail sales 4.1% Brand sales 5.3% PBT 6.8%
Source: J.P. Morgan estimates, Company data.
2013E -4.1% 0.2% 2,189 1,187 3,376 295 314 608 18.0% 589
2014E -1.4% 1.6% 2,246 1,270 3,516 290 346 636 18.1% 617
2015E 0.7% 3.0% 2,352 1,359 3,710 303 372 675 18.2% 655
2016E 3.5% 4.8% 2,528 1,454 3,982 348 400 748 18.8% 728
2017E 2.2% 4.0% 2,685 1,555 4,240 382 430 812 19.1% 791
In our retail break-even scenario, we explore the tipping point into loss given the estimated fixed cost base.
37
The key assumption here is to assume a persistently weak LFL in Retail (we begin with the bottom of the range for FY13E of -7% and assume a slight improvement in trend on an underlying basis throughout the period to 2017E). This is offset at Group level by strong and consistent growth in Directory (+9% in FY13E, +7% thereafter) to drive a broadly flat Brand LFL on average over the period (-0.6%). This compares to an average for the Brand LFL of -1.3% in the prior 5 years, so while a worst case, this scenario is far from apocalyptic. We have also reduced our space growth assumption from +4% pa over the entire period to +1% in FY15E and then flat thereafter. This drives a marginally worse marketing ratio as we assume that management would spend on marketing to drive sales. The ratio increases by 130bp over the 5 year period. All other assumptions stay as in the base case scenario. These assumptions result in a Retail EBIT of 0 in 2017E and a negative PBT 5-year CAGR of -6.7% and a cumulative fall in PBT of 167m between 2012 and 2017 to 403m.
Table 13: Scenario analysis: Retail EBIT goes to break even
Break-even Retail scenario Retail LFL Implied u/l Brand LFL Retail sales (m) Directory sales (m) Brand sales (m) Retail EBIT (m) Directory EBIT (m) Brand EBIT (m) Brand EBIT margin PBT (m) 5-year CAGR Retail sales Brand sales PBT 2012 -5.7% 0.9% 2,191 1,089 3,280 323 263 586 17.9% 570 -3.7% 0.6% -6.7% 2013E -7.0% -1.7% 2,126 1,187 3,312 253 308 560 16.9% 541 2014E -6.2% -1.5% 2,079 1,270 3,349 185 333 518 15.5% 499 2015E -5.2% -0.6% 1,992 1,359 3,350 117 361 478 14.3% 458 2016E -5.0% -0.1% 1,892 1,454 3,346 54 391 446 13.3% 426 2017E -4.0% 0.8% 1,816 1,555 3,372 0 424 424 12.6% 403
We think this scenario is unlikely. Nexts management team is undoubtedly high quality and thus would likely take action before such a severe scenario is realized. Nevertheless, a CAGR in LFL Brand sales of -0.6% is not dramatic, highlighting the extent of the risk in our view, to both profits and also sentiment if the Retail profit came anywhere near close to loss.
As discussed above a move to a break even position in Retail would likely be very negative for sentiment indeed, even if Directory sales compensated somewhat. Potentially, equally negative for sentiment, however, would be a decline of even 30% in Retail EBIT and the LFL threshold to reach that is much less dramatic. In essence, if we assume an average decline in Retail LFL of a mere 1.7% in the next 5 years (vs a historic 5 year average of -4.6%) we see a scenario where Retail EBIT falls by 30%.
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Under this scenario, we also assume that Directory sales growth is commensurately slower (under the assumption that the two are inversely correlated; ie the rate of decline in Retail LFL would only slow if the Directory growth also slowed). This implies a flat Brand LFL over the period, implying some loss of market share for Next on a combined basis. In this scenario our PBT is flat over a 5 year period, which would not, we believe be a bad outcome at the group level. However, the impact on sentiment of a 30% decline in Retail EBIT would we believe be significant.
Table 14: Scenario analysis; EBIT falls by 30% over 5 years
EBIT falls by 30% Retail LFL Implied u/l Brand LFL Retail sales (m) Directory sales (m) Brand sales (m) Retail EBIT (m) Directory EBIT (m) Brand EBIT (m) Brand EBIT margin PBT (m) 5-year CAGR Retail sales Brand sales PBT 2012 -5.7% 0.9% 2,191 1,089 3,280 323 263 586 17.9% 570 0.3% 1.7% 0.0% 2013E -2.9% 1.0% 2,216 1,187 3,402 306 308 614 18.0% 594 2014E -2.0% 0.4% 2,260 1,246 3,506 290 327 617 17.6% 598 2015E -1.5% 0.1% 2,271 1,283 3,555 271 341 612 17.2% 592 2016E -1.0% 0.1% 2,248 1,309 3,557 249 352 601 16.9% 581 2017E -1.0% 0.1% 2,226 1,335 3,561 227 363 590 16.6% 569
39
Valuation
Nexts shares have risen by 49% since the beginning of 2011, outperforming the wider retail sector by 46%. This puts the shares on a PER of 12.3x, which is a premium to sector of 11.3%, reflecting the inherent investment attractions of its well regarded management team, resilient profit line, share buyback strategy and attractive cash flows and high ROIC.
ROICs
Figure 32: ROIC Comparison
30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00%
The shares have historically been driven by earnings momentum and in 2011 benefited on a relative basis versus the rest of the sector which was delivering downgrades. This situation could reverse this year if Next holds estimates when everyone else upgrades.
A possible explanation for this de-coupling is that Next shares have performed according to relative earnings revisions versus the wider sector, rather than absolute revisions of its own earnings estimates. That is, in 2011estimates for Next experienced an effective upgrade relative to peers as we saw estimates across the sector consistently revised down throughout the year (for example, consensus expectations at the start of CY 2011 were for Retail sector earnings growth of +12% versus realised sector growth of +4.3%). Looking ahead, if we are correct in our sector view that estimates across the peer group now look sensibly based with upside risk to CY13 (from the combination an improving consumer macro and high operational gearing), the opposite scenario could occur. That is, in the absence of upgrades to Next estimates versus the wider sector, the share could de-rate on a relative basis.
40
Source: Bloomberg
Discounted economic profit analysis allows us to better assess Nexts long-term prospects Given the focus on the cash generation and superior ROIC of the Next business (25.8% fully adjusted), we believe it appropriate to examine the business on a discounted economic profit and discounted cash flow basis. Both analyses examine the future earnings stream of a business with the discounted present value of the future free cash flows equating to the discounted present value of the economic profit generated by the business. The economic profit being equivalent to the EBIT adjusted to a cash based net operating profit after taxes (NOPLAT) less a capital charge for invested capital (WACC x Invested Capital). Most notably in our three stage hold and fade discounted economic profit analysis, we have capitalised up Next's operating leases and included the capitalised value in our invested capital, while also adding the lease charge back on to our EBIT in the NOPLAT calculation. Our key assumptions are as follows: During the explicit period (3 years) we have utilized our existing estimates for turnover, NOPLAT and invested capital. We can see from this that we expect Next to deliver turnover growth of sub 1%, an invested capital decline of 2% (this tallies with managements indications that depreciation will run at slightly more than capex over the next 2/3 years) and a pre-tax margin, which is falling by 60bp pa (see Outlook section for more detail) from its very high level. A semi-explicit (hold) period also of 3 years during which time invested capital is flat (with depreciation matching capex), turnover continues to decline at a slightly higher rate of -2-3% and pre-tax margin continues to drop by 60bp pa. A fade period of 10 years over which Nexts current very high ROIC converges with its estimated cost of capital of 8%. During this period turnover continues to fall by 2% pa, while pre-tax margin also declines by c. 80bp pa in the early years accelerating in later years to reach a level of 8.2% - approximately half of the level expected at the end of the semi-explicit period and actually broadly in line with that delivered by many clothing peers. This move may seem extreme, but should be considered within the context of the scenario analysis and in the context of the relatively benign turnover forecasts (ie., we believe the margin sacrifice protects the turnover).
Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12
Next
EPS Ests.
41
We use a WACC of 8% We use an average lease length of 8 years and a yield of 6% to capitalize our leases, giving an overall implicit capitalized lease value of 633m
Table 15: Discounted economic profit analysis vs discounted cash flow
Discounted economic profit PV of economic profit PV of tax shield Opening invested capital Appraised value of the enterprise Value of non-core assets Value of debt Value of minorities Appraised value of the equity Number of shares (m) Appraised share price (p) Current share price (p) Upside/(downside)
Source: J.P. Morgan estimates, Company data.
Discounted cash flow PV of operating free cash flows PV of tax shield Value of non-core assets Value of debt Value of minorities Appraised value of the equity Number of shares (m) Appraised share price (p) Current share price (p) Upside/(downside)
Cost of equity/ROIC
10
2013
2016
2019
2022
2025
IC (RHS)
T/over (RHS)
ROIC
Cost of capital
Table 16: Sensitivity of fair value to fade and cost of capital assumptions
6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5%
Source: J.P. Morgan estimates, Company data.
2028
Our analysis returns an implied fair value of 16.76; doubling our fade period to 20 years would increase this by c. 13% to 18.90 still well below the current share price
Our discounted economic profit analysis returns a value of 16.76 per share, a discount of 43% to the current share price (Table 13). While we are comfortable in our estimates and assumptions, this seems quite aggressive (Table 12: also shows the sensitivity of our model to changes in the fade period and cost of capital) and it may well be more appropriate to use a 20 year fade period, albeit this seems overly generous in the context of the rapidly changing competitive and structural environment within apparel retail.
42
100
This would still return an implied value significantly below the current share price and hence we have also approached the valuation from the opposite direction i.e. by assessing the level of growth or length of superior returns implied by the current share price. Growth implied by current valuation (2921p as at April 16) Working back from the current valuation, we can see the following key assumptions need to be made: Post the explicit forecast period, turnover remains consistently at +1% for the 13 years hold and fade period. Pre-tax margin remains at 18.5% in line with the level we expect at the end of the 3 year explicit period despite the pressures on margin discussed in the outlook and scenario section. This allows Next to generate a ROIC significantly above its cost of capital indefinitely (Figure 35) despite the absence of a unique proprietary product or indeed any evidence from other apparel players that it is possible to earn such super-normal returns within apparel for an indefinite period of time.
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2013 2016 2019 2022 2025 2028 1000
To justify the current share price we need to assume that Next is able to generate its current extremely high ROIC indefinitely
Figure 35: Discounted economic profit progress implied by current share price
Cost of equity/ROIC
10
IC (RHS)
T/over (RHS)
ROIC
Cost of capit al
This seems an unlikely scenario for the reasons given above, and it seems more likely that the most probable outcome lies somewhere in between the two valuations, although we would stress that our initial estimate of 16.76 is based on our existing forecasts not on the downside outcomes possible if the market were to move to free delivery. Given the wide range of estimates and the number of moving parts in the business, we have carried out the discounted economic profit exercise for our three scenarios (see scenario section). We have then equally weighted all three of these possible outcomes together with the valuation driven by our current estimates and discussed above. This returns a per share value of 20.39, which we adopt as our 12M TP. This is 33% discount to the current share price.
Table 17: Probability weighted discounted economic profit
BBG base case Retail break even 30% downside in Retail JPMC base case Implied equal weighted implied value (p)
Source: J.P. Morgan estimates, Company data.
m
43
100
We consider the closest peers to Next to be Marks & Spencer (similar geographic exposure to the relatively mature UK clothing market) and Kingfisher. Whilst in the latter case the product categories and geographic exposure is different, both have highly respected management teams, robust balance sheets and are regarded as top quality stocks within in the UK sector. Whilst we have included the European retailers for comparative purposes, the substantial roll-out potential and more diverse geographic exposure of these stocks means that we would not include them in Nexts core peer group. We have also included Debenhams, which in terms of customer demographic offers a good degree of overlap with Next. Nexts free cash flow yield is impressive and is the highest amongst the large cap peer group (Debenhams offers a FCF yield 50bps ahead of Next in CY12E), but on all other metrics both Kingfisher, M&S and Debenhams appear better value. On the key valuation measures of PE and EV/EBITDA in particular Next is expensive versus the UK peer group trading at a 18% and 26% premium respectively for CY12 and 27% and 35% for CY13. Furthermore, on a PEG basis Next is trading on 4.4x, albeit on our bottom of the range estimates for 2 year EPS CAGR of +2.8%, highlighting the limited growth potential versus peers on an underlying basis.
Figure 36: Forward PER Comparison
30 25 20 15 10 5 0
Source: Datastream
We therefore consider that to still be appropriate and would highlight in particular its relationship to Kingfisher, which has superior earnings growth (c. 13.7% pa). While we accept Next has considerable cash generation attractions as well as the support of a buyback, Kingfisher also appears to be building up a cash pile and could in theory return cash to shareholders in future. Next has an expected 2 year CAGR in EPS of only 2.8%, which is less than the UK peer group average of c.8%.
Table 18: Peer Group Comparison
PE CY12 H&M Inditex Debenhams Kingfisher M&S Next Average UK average Next vs. UK average 22.0 20.1 8.4 10.9 10.1 12.3 14.0 10.5 18.1% CY13 20.1 18.2 7.1 9.6 9.7 12.2 12.8 9.7 26.7% 2.4 1.7 0.6 0.7 1.9 4.4 1.9 1.9 132.3% PEG EV/EBITDA CY12 CY13 13.8 10.6 5.1 5.8 5.6 7.7 8.1 6.0 26.9% 12.8 9.7 4.6 5.2 5.4 7.8 7.6 5.8 35.8% FCF yield CY12 CY13 3.8% 4.3% 8.3% 4.4% 5.9% 7.8% 5.8% 6.6% 1.2% 3.8% 5.2% 12.5% 6.4% 3.1% 7.9% 6.5% 7.5% 0.4% Dividend yield CY12 CY13 4.4% 2.7% 3.9% 3.3% 4.6% 3.2% 3.7% 3.8% -0.5% 4.6% 3.0% 4.6% 3.8% 4.9% 3.6% 4.1% 4.2% -0.7% EPS CAGR CY11-13 8.5% 10.8% 12.0% 13.7% 5.1% 2.8% 8.8% 8.4% -5.6% Net debt/ EBITDA FY12 -0.5 -1.3 1.4 -0.1 1.5 0.8 0.3 0.9 -11.9%
44
Jan 87 Dec 87 Nov 88 Oct 89 Sep 90 Aug 91 Jul 92 Jun 93 May 94 Apr 95 Mar 96 Feb 97 Jan 98 Dec 98 Nov 99 Oct 00 Sep 01 Aug 02 Jul 03 Jun 04 May 05 Apr 06 Mar 07 Feb 08 Jan 09 Dec 09 Nov 10 Oct 11
Next Forward PER Kingfisher Forward PER Marks & Spencer Forward PER
2011E
2012E
2013E
2014E
Source: Verdict
2015E
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2000-05
Source: Verdict
2005-10
2010-15
46
47
JPM Q-Profile
Next PLC (BRITAIN / Consumer Discretionary)
As Of: 13-Apr-2012 Quant_Strategy@jpmorgan.com
Current:
29.50
Current:
2.72
Nov/08
Jun/09
Jan/10
Aug/10
Mar/11
Oct/11
-0.50 May/98 Jul/99 May/05 Mar/97 Oct/97 Dec/98 Feb/00 Sep/00 Apr/01 Nov/01 Jun/02 Jan/03 Aug/03 Mar/04 Oct/04 Dec/05 Jul/06 Feb/07 Sep/07 Apr/08 Nov/08 Jun/09 Jan/10 Aug/10 Aug/10 Aug/10 Mar/11 Mar/11 Mar/11 Mar/11 Oct/11 Oct/11 Oct/11 Oct/11
Current:
9%
Current:
-27.38%
Nov/08
Jun/09
Jan/10
Aug/10
Mar/11
Oct/11
Jun/09
PE (1Yr Forward)
25.0x 20.0x 15.0x 10.0x 5.0x 0.0x Mar/97 Oct/97 May/98 Dec/98 Jul/99 Feb/00 Sep/00 Apr/01 Nov/01 Jun/02 Jan/03 Aug/03 Mar/04 Oct/04 May/05 Dec/05 Jul/06 Feb/07 Sep/07 Apr/08
Current:
10.9x
Price/Book Value
60.0x 40.0x 20.0x 0.0x -20.0x -40.0x -60.0x
PBV hist PBV Forward
Current:
Jan/10
22.4x
Nov/08
Jun/09
Jan/10
Aug/10
Mar/11
Oct/11
-80.0x Mar/97 Oct/97 May/98 Dec/98 Jul/99 Feb/00 Sep/00 Apr/01 Nov/01 Jun/02 Jan/03 Aug/03 Mar/04 Oct/04 May/05 Dec/05 Jul/06 Feb/07 Sep/07 Apr/08 Nov/08 Jun/09 Jan/10
ROE (Trailing)
1,600.00 1,400.00 1,200.00 1,000.00 800.00 600.00 400.00 200.00 0.00 Mar/97 Oct/97 May/98 Dec/98 Jul/99 Feb/00 Sep/00 Apr/01 Nov/01 Jun/02 Jan/03 Aug/03 Mar/04 Oct/04 May/05 Dec/05 Jul/06 Feb/07 Sep/07 Apr/08
Current:
190.90
Current:
3.02
Jun/09
Jan/10
Nov/08
Jun/09
Jan/10
Aug/10
Mar/11
Summary
Next PLC BRITAIN Consumer Discretionary 12mth Forward PE P/BV (Trailing) Dividend Yield (Trailing) ROE (Trailing) Implied Value of Growth 7888.02 32.8578 SEDOL 3208986 Multiline Retail Latest Min 6.07 10.86x -55.15 22.35x 1.97 3.02 24.00 190.90 -0.84 -27.4% As Of: Local Price: EPS: % to Max % to Med 94% 14% 117% -70% 91% -2% 599% -38% 310% 161% 13-Apr-12 29.50 2.72 % to Avg 19% -61% 3% 29% 131%
Source: Bloomberg, Reuters Global Fundamentals, IBES CONSENSUS, J.P. Morgan Calcs
* Implied Value Of Growth = (1 - EY/Cost of equity) where cost of equity =Bond Yield + 5.0% (ERP)
48
Aug/10
Oct/11
FY11 FY12 -4.0% -5.7% 16.9% 17.3% 17.3% 14.8% 24.9 21.4 58.9% 49.6% 14.5 8.4 2.6% 12.7 8.1 3.0%
FY14E FY15E -6.0% 16.5% 15.8% 0.6% 20.9 44.2% 12.1 8.4 3.6% 0.2% 20.2 12.1 8.7 4.0%
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Date 04-Apr-07
Next Plc (NXT.L, NXT LN) Price Chart
5,278 OW 2,160p OW 2,100p 1,275p UW 1,055p N N 1,120p UW 1,400p 4,524 N 2,160p N 1,200p1,050p 1,025p 1,150p OW 2,400p N UW UW 3,770 N 2,000p N OW 2,250p 2,052p N 1,500pN 1,100p1,000p 1,050p UW UW 3,016 Price(p) 2,262 1,508 754 0 Feb 07 Nov 07 Aug 08 May 09 Feb 10 Nov 10 Aug 11 OW UW 2,032p1,620pUW 1,948p UW UW 1,670p
Rating Share Price (p) N N N OW OW OW N N N N N UW UW UW UW UW OW UW UW UW 2286 1842 1886 1869 1935 2145 1602 1300 1179 1284 974 922 1143 948 1189 1098 1231 1255 1640 1875 2133 1924 2319 2592
Price Target (p) 2000 2052 2160 2160 2250 2400 2100 1500 1200 1275 1100 1050 1120 1000 1025 1055 1050 1150 1400 -2032 1620 1670 1948
25-Jul-07 23-Aug-07 28-Aug-07 20-Sep-07 30-Oct-07 21-Jan-08 19-Mar-08 27-Jun-08 17-Jul-08 10-Sep-08 13-Oct-08 05-Nov-08 22-Jan-09 19-Mar-09 29-Mar-09 01-Mar-10 04-Nov-10 03-Mar-11 28-Sep-11
17-Dec-07 OW
19-May-08 N
06-May-09 UW
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Break in coverage Mar 01, 2010 - Nov 04, 2010.
04-May-11 UW
The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings: OW = Overweight, N= Neutral, UW = Underweight Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] In our Asia (ex-Australia) and UK small- and mid-cap equity research, each stocks expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analysts coverage universe can be found on J.P. Morgans research website, www.morganmarkets.com. Coverage Universe: Hilditch, Gillian: ASOS (ASOS.L), Debenhams (DEB.L), Dunelm Group plc (DNLM.L), Halfords (HFD.L), Hennes & Mauritz (HMb.ST), Home Retail Group (HOME.L), Howden Joinery Group Plc (HWDN.L), Inchcape (INCH.L), Inditex (ITX.MC), Kingfisher Plc (KGF.L), Marks & Spencer (MKS.L), Mothercare (MTC.L), Next Plc (NXT.L)
50
J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients*
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(JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services Authority. Registered in England & Wales No. 2711006. Registered Office 125 London Wall, London EC2Y 5AJ. South Africa: J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. Hong Kong: J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission in Hong Kong. Korea: J.P. Morgan Securities (Far East) Ltd, Seoul Branch, is regulated by the Korea Financial Supervisory Service. Australia: J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) is regulated by ASIC and J.P. Morgan Securities Australia Limited (ABN 61 003 245 234/AFS Licence No: 238066) is a Market Participant with the ASX and regulated by ASIC. 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Morgan Securities Philippines Inc. is a member of the Philippine Stock Exchange and is regulated by the Securities and Exchange Commission. Brazil: Banco J.P. Morgan S.A. is regulated by the Comissao de Valores Mobiliarios (CVM) and by the Central Bank of Brazil. Mexico: J.P. Morgan Casa de Bolsa, S.A. de C.V., J.P. Morgan Grupo Financiero is a member of the Mexican Stock Exchange and authorized to act as a broker dealer by the National Banking and Securities Exchange Commission. Singapore: This material is issued and distributed in Singapore by J.P. Morgan Securities Singapore Private Limited (JPMSS) [MICA (P) 088/04/2012 and Co. Reg. No.: 199405335R] which is a member of the Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore (MAS) and/or JPMorgan Chase Bank, N.A., Singapore branch (JPMCB Singapore) which is regulated by the MAS. Malaysia: This material is issued and distributed in Malaysia by JPMorgan Securities (Malaysia) Sdn Bhd (18146-X) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets Services License issued by the Securities Commission in Malaysia. Pakistan: J. P. Morgan Pakistan Broking (Pvt.) Ltd is a member of the Karachi Stock Exchange and regulated by the Securities and Exchange Commission of Pakistan. Saudi Arabia: J.P. Morgan Saudi Arabia Ltd. is authorized by the Capital Market Authority of the Kingdom of Saudi Arabia (CMA) to carry out dealing as an agent, arranging, advising and custody, with respect to securities business under licence number 35-07079 and its registered address is at 8th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 51907, Riyadh 11553, Kingdom of Saudi Arabia. Dubai: JPMorgan Chase Bank, N.A., Dubai Branch is regulated by the Dubai Financial Services Authority (DFSA) and its registered address is Dubai International Financial Centre - Building 3, Level 7, PO Box 506551, Dubai, UAE. Country and Region Specific Disclosures U.K. and European Economic Area (EEA): Unless specified to the contrary, issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL's policies for managing conflicts of interest arising as a result of
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publication and distribution of investment research. Many European regulators require a firm to establish, implement and maintain such a policy. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to "wholesale clients" only. JPMSAL does not issue or distribute this material to "retail clients". The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms "wholesale client" and "retail client" have the meanings given to them in section 761G of the Corporations Act 2001. Germany: This material is distributed in Germany by J.P. Morgan Securities Ltd., Frankfurt Branch and J.P.Morgan Chase Bank, N.A., Frankfurt Branch which are regulated by the Bundesanstalt fr Finanzdienstleistungsaufsicht. Hong Kong: The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider/market maker for derivative warrants, callable bull bear contracts and stock options listed on the Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk. Japan: There is a risk that a loss may occur due to a change in the price of the shares in the case of share trading, and that a loss may occur due to the exchange rate in the case of foreign share trading. In the case of share trading, JPMorgan Securities Japan Co., Ltd., will be receiving a brokerage fee and consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed between JPMorgan Securities Japan Co., Ltd., and the customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. 82 Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan, Type II Financial Instruments Firms Association and Japan Securities Investment Advisers Association. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul Branch. Singapore: JPMSS and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. 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Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules. General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst's involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. "Other Disclosures" last revised April 18, 2012.
Copyright 2012 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan. #$J&098$#*P
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