Next: gradual reinvention of a retail stalwart

High street stalwart Next is adapting well amid turmoil in the retail sector.

916_MW_P36_Companies

Next's flexibility makes it a promising long-term bet

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.

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.

Recommended

The top funds to invest in
Funds

The top funds to invest in

Investors continued to the passive preference throughout May, while high-yields were also sought. We look at the top funds, stocks and trusts that inv…
5 Jun 2023
Look beyond the blue chips for the best bargains in British income stocks
Share tips

Look beyond the blue chips for the best bargains in British income stocks

A professional investor tells us where he’d put his money. This week: Chris McVeyof the FP Octopus UK Multi Cap Income Fund highlights three favourite…
23 May 2023
It’s fallen hard – but is now the time to buy Scottish Mortgage Investment Trust?
Investment trusts

It’s fallen hard – but is now the time to buy Scottish Mortgage Investment Trust?

Shares in the Scottish Mortgage Investment Trust have plunged 45% since the beginning of 2022. We take a look at the trust's performance and discuss w…
22 May 2023
Three British stocks offering all-weather income
Share tips

Three British stocks offering all-weather income

A professional investor tells us where he’d put his money. This week: Brendan Gulston, co-manager of the LF Gresham House UK Multi Cap Income Fund.
17 May 2023

Most Popular

Best savings accounts – June 2023
Savings

Best savings accounts – June 2023

Interest rates have been creeping up - we look at the best savings accounts on the market right now.
6 Jun 2023
Nationwide to give £100 cash boost to customers
Personal finance

Nationwide to give £100 cash boost to customers

Nationwide Building Society is giving customers £100 as it reinvests profits. Dubbed the Nationwide Fairer Share scheme, we look at who is eligible.
22 May 2023
Holiday rip-off: Millions of travellers hit with hidden costs by using debit card abroad
Personal finance

Holiday rip-off: Millions of travellers hit with hidden costs by using debit card abroad

A family of four on a week-long trip to France could pay an extra £212 in fees by using their everyday bank card compared to the lowest-cost option, a…
23 May 2023