Next profits shrink as pursuit of clothing trends hits sales

Clothes retailer Next reported underlying annual profits fell for the first time in eight years and warned 2017 will be "another tough year" due to a shift away from spending on clothing and a squeeze on UK wages.

Furthermore, management admitted their focus on following fashion trends had seen them neglect their "heartland product" and so sales are expected to fall in the first half of the year before measures to resurrect the product range are expected to lead a recovery from the autumn season.

Chief executive Simon Wolfson said: "The year ahead looks like it will be tough with a combination of economic, cyclical and internal factors working against us. Our reaction to these challenges will be, as it has been in the past, to acknowledge where we can improve and focus on our core business."

He said while Next had substantially improved its ability to respond to new trends and been rewarded with good sales, "in the process of making our ranges more responsive, we have omitted some best-selling, heartland product" and so since the start of the year had taken corrective action.

"This work will begin to be reflected in our ranges as the summer season progresses. However, our ranges will not be exactly where we want them to be until we get into the third quarter.

"So we expect sales in the first quarter to be around the lower end of the 2017/18 guidance range we issued with our January 2017 trading statement. All other things being equal, we expect some improvement in the second quarter and a more marked improvement in the second half of the year. This, of course, is subject to there being no further deterioration in the external environment as the year progresses."

For the last financial year up to the end of January, total sales shrank 1.9% to £4.1bn as store revenues contracted 2.9% but sales for Next Directory, the catalogue and online business, increased 4.2%.

Cost increases, mainly from wages, of £41m were offset last year with cost savings of £42m and in the coming year Wolfson expects increases of around £36m to be partly balanced by around £26m of savings.

Underlying pre-tax profits fell 3.8% to £790.2m but earnings per share declined only 0.3% to 441.3p, helped by share buybacks, but for the current year growth profits and EPS are expected to grow between -12.4% and +0.5% due to mounting cost pressures.

The total full year ordinary dividend was held flat at 158p the first of the four 45p special dividends promised in at the January 2017 trading statement was confirmed that it will be paid on 2 May.

Reaction and analysis

Shares in Next bounced 6% to 4,127p in the first hour of trading on Thursday, having collapsed from close to 5,000p on January's profit warning.

Analysts at Investec upgraded the shares as they took confidence from the valuation, at less than 10 times current year earnings, together with strong cash generation supporting the dividend yield and management's unchanged guidance - albeit with the second-half weighting.

The results were distinctly mixed, though, with retail disappointing as margins come under "notable pressure" due to a weak top line, negative gearing and poor markdown, but Directory showed signs of improvement and credit customer churn showed signs of improvement.

"Although some decline is anticipated in the year ahead, this development is interesting and could bring some stability into the credit element of Directory allowing Cash, Label and International to drive future growth," Investec said.

Analyst Naeem Aslam at Think Markets said the UK clothing sector was facing the perfect recipe for a disaster, with wages not keeping up with inflation and retailers facing higher input costs.

"There is no denial in saying that higher inflation is biting retailers, but the reality is that Next has its own specific issues which are hunting its outlook. Their online presence and fashion trend are lacking the very spice which consumers crave.

He said it was only so long that Next could absorb higher costs before they actually pass those on to consumers, while the cyclical slowdown in consumer spending is likely to worsen in coming months - "a lose-lose situation".

"So perhaps, retail sector may not be the best option to look at if you are looking for investment as we think the path of least resistance is skewed towards the downside."