The endless tales of woe from the retail sector have persuaded many investors that any company operating physical stores is destined for the dustbin of history while only new online brands have a future. In fact, the distinction between online and physical stores is blurring.
Amazon is experimenting with shops, and Next (LSE: NXT) expects to earn more revenue online than it does from people walking through its doors this year. The distinction between retail and distribution is also vanishing as Amazon fulfils the orders of millions of retailers.
Perhaps Next has a big future in distribution, too. At the company's annual general meeting in 2017 I asked its feted chief executive, Lord Wolfson, about change. Young adults and teenagers are drawn to youthful online brands such as Asos and boohoo, while the pillars that support Next's high levels of profitability are eroding.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Directory, Next's pioneering and peerless catalogue, has moved online, where it now rubs shoulders with countless retailers. Meanwhile, interest on customer accounts has been a big source of income for Next over the years, but online it is easier, and often cheaper, for customers to just pay by credit card than it is to open a credit account with the company.
Label: a new marketplace
I wanted to know what advantages Next was building for the future. Wolfson replied that Next's distribution network is so efficient it could be other brands' most profitable route to market.
The section of Next's website that sells other brands is called Label. It sells premium brands such as Ted Baker, Joules and Barbour. It also offers youth brands like boohoo and Missguided.
These products don't compete directly with Next's own brand, which is adult and mainstream. While Label earned a relatively modest £300m of revenue in the year to January 2018 about 8% of Next's total that figure is twice what it was three years ago. What's more, according to the company's recent half-year results it is still growing much faster than online sales of Next's own brand. The other opportunity Wolfson mentioned is Europe "virgin territory". Online revenue from overseas is also nearly £300m and growing rapidly.
Next has ramped up digital marketing spending and investment in its distribution network. It has improved stock control using RFID technology, networking stores so they can operate as warehouses, supplying the online operation and each other when short of stock. The company is also developing systems to allow other brands to manage their stock in Next's warehouse and on the website, so stores can serve as delivery points for other brands.
What next?
For all Next's industry, though, growth in online sales must continue apace to secure the future, because the profitability of the retail stores is falling as shoppers move online.
Most of the cost of bricks and mortar retailing, like rent, rates and electricity, is fixed but the more clothes Next sells online, the more postage it pays and the more returns it must handle.
The upshot is that as store sales fall, profit falls faster, but as online sales increase, online profit moves more or less in step with revenue. Even though rising online revenue has more than compensated for falling revenue in stores, it can still result in a reduction in overall profit.
Still, I don't think shareholders should be alarmed. Next remains far more profitable than most rivals, high street or online. In the year to January 2018 it earned an after-tax return on capital of 20% only 2% below the average for the past ten years. Next's average lease term of six years is relatively short, making it easier to close less profitable stores.
When the stores close, Next finds that a significant amount of business transfers to neighbouring outlets, mitigating much of the lost profit.
Meanwhile, to boost profit and footfall it must find things to sell that people prefer not to buy online, another facet of its gradual reinvention (see below). Next is among the few established retailers who have the wherewithal to adapt to a difficult new environment.
-
Should you sell in May this year?The market adage looks unlikely to apply in 2024, and global equities are proving resilient
-
Should you invest in UK equities?The FTSE 100 hit a record high this week, but UK equities remain unloved and undervalued compared to their global and US peers. Should you snap them up at a discount?
