After a strong finish to 2019, the Next (LSE: NXT) share price has fallen by more than 45% so far this year. The group surprised investors in March by shutting down its online operations as well as its stores.
Here, I’ll explain what I think has happened and why I believe this FTSE 100 retailer could be a profitable buy at current levels.
A calculated decision?
Next shut its stores in March along with all other non-essential retailers. Just before this happened, the company said it had modelled the numbers on store closures and could “comfortably sustain” the loss of 25% of its sales this year without any financial distress.
But boss Lord Wolfson surprised the market a few days later by announcing the closure of its warehousing and online operations. This pushed Next’s share price even lower. Investors started to wonder if this previously successful retailer could actually go under.
Next’s explanation for this voluntary closure was that many of its warehouse staff felt “they should be at home in the current climate.” That’s fair enough. But I wonder if this decision was also influenced by the firm’s financial analysis of the situation.
This could speed up a recovery
In normal times, nearly 50% of Next’s online sales are sent to stores for click & collect. And 80% of online returns are taken back to stores.
With all of the group’s stores closed and order volumes falling, I imagine the group’s online operation was incurring higher postage costs and operating less efficiently than normal. I wonder if Next’s management calculated that it would be cheaper to shut online than to keep trading in such circumstances.
With warehouses shut, I assume their staff will be paid through the government’s furlough scheme. This could save Next’s cash. Meanwhile, the company will be able to minimise the amount of unwanted stock it holds, which might later have to be sold at a loss.
In my view, the decision to close online could speed up the eventual recovery of Next’s business (and its share price).
Why I’d buy the Next share price
Adverts for investment funds always warn that past performance is no guide to the future. But when it comes to company management, I think past performance is often a useful guide.
I’ve been following Next for many years and several things have always been true. This retailer has always been one of the most profitable businesses in the FTSE 100. Last year, Next reported an operating margin of 20% and a return on capital employed of 31%. These are very high figures for any business, let alone a high street retailer.
Next has never had too much debt and always enjoys strong cash generation. Dividends and share buybacks are always supported by surplus cash.
Management, led by Lord Wolfson, always show great skill at analysing and modelling the company’s performance. Their forecasts are usually precise and reliable.
As I write, the Next share price is just under 3,700p. This prices the stock on about nine times forecast earnings for 2020/21. The market seems to be pricing this business for a long-term decline.
I don’t agree. I think Next shares are likely to be a profitable buy, at this level.
The post The Next share price has fallen by 45%. Here’s why I’d buy it today appeared first on The Motley Fool UK.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020