Next issues fresh profit upgrade but worried about taxes

The Next (LSE:NXT) engine continues to purr as the group retains its laser focus on identifying growth opportunities in a famously competitive environment.

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Last month’s trading update trailed much of the financial detail, apart from the almost inevitable profit upgrade which has resulted. Guidance for full-year pre-tax profit has been raised to £1.255 billion from a previous £1.243 billion, which would represent growth of 10.3% from the corresponding period. Full-price sales are expected to grow by 6.7% to £6 billion, all underpinned by the group’s aims of improving product, international growth, upgrading its infrastructure and controlling costs.

Meanwhile, shareholder returns remain another major investor attraction, swinging between share buybacks or special dividends depending on the level of the share price. At present, the share buyback is effectively on hold given the group’s new threshold of £135 per share before continuing with the programme. As such, the pendulum has swung to the dividend, which including specials is currently running on an attractive 4.4% yield and the balance of excess cash will find its way back to shareholders via either route.

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Revenues for the half jumped 9% to £3.54 billion against a market estimate of £3.42 billion, with pre-tax profit growing by 10.5% to £569 million. Full price sales for the second quarter grew 7.7% and group sales by 9%, with the company attributing the outperformance to warmer weather, the release of some pent-up demand in the Middle East and Northern Europe after a subdued first quarter, and a higher profitable marketing spend.

The swan-like performance of the group, with visibly serene and graceful moves propelled by invisible furious paddling, is no accident. Next has a forensic approach to each and every line of its business which results in any number of small and incremental wins which in aggregate lead to relentless growth. An obvious example of this is the international business, which saw full-price sales growth of 23.9% over the half-year and 59% compared to two years ago. There is a combination of factors here. On the one hand, digital marketing has proved so successful that it allows for more of the same, which creates a virtuous circle.

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Another driver for international comes from Next’s previously stated strategy, which underline the group’s unparalleled understanding of the markets in which it operates and its ability to capitalise on new opportunities. The group believes that international tastes in clothing are beginning to converge, not least of which is due to the increasing visual power, appeal and presence not just of the internet, but also the rise of streaming services which are now increasingly used by younger audiences.

The group is mindful of the continuing challenges in the physical retail space in the UK, where store sales fell by 1.7% over the six months. Although this was more than offset by strength elsewhere, it remains an area on which Next will focus. Much has been made across the sector of the inflationary impact of higher energy prices from the current conflict which threatens to heighten input costs as well as crimp consumer demand.

The group, which has a 6% of overall sales exposure to the Middle East, has responded to the threat by setting aside £47 million for additional costs, although the figure will be offset by savings and price increases elsewhere. Next is nonetheless mindful that should the conflict carry on for an extended period, some suppression of sales would inevitably follow.

In addition, the Next brand saw a slight dip in sales in the UK which leads the company to monitor the situation carefully. The benefit of last year’s cyber disruption at Marks & Spencer has of course passed, while the success of its wholly-owned and third-party brands may have had some substitution effect on its own brand.

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More broadly, rising inflation, higher mortgage costs and the possibility of further tax increases in the upcoming Budget could be meaningful headwinds. Indeed, Next makes the valid point that the Government tax burden is at its highest level in over 60 years and that further tax increases could stifle growth and therefore worsen the finances further in something of a vicious cycle.

Even so, Next has shown its mettle once more in a famously competitive environment, in which it is seen as something of a linchpin. The share price has risen by 21% over the last year, as compared to a gain of 16% for the wider FTSE100, and by 102% over the last three years, which is a considerable achievement given the traditional restraints which retail stocks face. And, while the share price and the valuation may be breaking new and unchartered ground, so are growth and profits.

As such, and given the group’s ability to deliver time and time again, the market consensus of the shares as a buy reflects that investors recognise the singular strength of this slick and well-regarded company.