Turkey of the week: retailer squeezed by its rivals

By Paul Hill Oct 02, 2009

Paul Hill

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The retail sector has shot up by 85% from its December lows. And fashion house Next is one of the City's favourites – all but one of 28 brokers favour it. But I think they're wrong. Despite growing its franchised international unit, Next is still far too reliant on the UK, owning 515 stores and accounting for around 7% of the UK clothing market.

Sure, it's been one of the most resilient chains in the downturn; its catalogue business in particular has done well as households have tightened their purse strings. The group has even upgraded its year-end profit forecasts, which are expected to be "close to" last year's £429m figure, thanks to better-than-expected stock clearance and summer trading.

But this may not last. Shoppers are treating themselves thanks to lower mortgage and utility bills, along with a spot of hot weather. But unemployment is rising, and consumers face the prospect of higher taxes in 2010, on top of a 2.5% VAT hike from 31 December onwards.

Next (LSE: NXT), rated a BUY by Pali International

Worse still, as new stores open (14 are planned before January) then sales densities are likely to fall, hitting like-for-like (LFL) revenues and profits due to the group's high operational gearing. This is already happening – the board believes LFLs will fall 3.5-6.5% in the second half, with 2010 not set to be any better.

Fashion is notoriously fickle. What may be trendy one moment could become passé in the blink of an eye. Next's mid-market position could also be squeezed by cut-throat competition from the likes of Tesco at the bottom, heavy discounting by M&S in the middle, and brand extensions from Burberry at the top.

I would rate the stock on a through cycle eight times EBITA multiple – assuming 13% profit margins on £3.3bn turnover. After adjusting for net debt of £514m, this delivers an intrinsic worth of around £14.30 a share. If you were lucky enough to have snaffled some shares at 840p in November and are sitting on 110% gains, it's time to trouser the profits.

Recommendation: SELL at £17.92

• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

Published in Tips & advice | More articles by Paul Hill

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