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The Next (LSE: NXT) share price is edging higher in morning trading on Thursday 8 May, after the company upgraded its profit guidance for the second time this year.
Shares in this FTSE 100 retailer have now doubled in three years.
In this piece I’ll explain why Next is doing so well – and whether I’m buying the shares.
Warm weather boost?
Next says that sales during the first quarter of its financial year (to late April) were £55m higher than expected. The company had previously forecast an increase of 6.4% compared to last year, but actual sales were 11.4% higher.
The sales boost seems to have been driven by the early warm weather, with extra sales focused on “summer-weight clothing”. Next’s management reckons shoppers brought forward purchases they’d normally have made from May through to July.
Sales forecasts for the rest of the year have been left unchanged. But the Q1 boost to sales is enough to allow Next to lift its full year pre-tax profit guidance by £14m to £1,080m.
That’s equivalent to an earnings forecast of 698p per share, almost 10% higher than last year.
Next’s secret sauce!
In recent years, the high street stalwart has given other retailers a masterclass in how to adapt and profit from online retail. By building a portfolio of brands, the group has added new customers and found new sources of growth.
Another advantage that’s often overlooked is the company’s nextpay credit business, which allows customers to buy now and pay later.
Credit services added about 18% to Next’s trading profits last year, lifting the group’s operating profit margin to nearly 18%.
As far as I can see, that makes Next the most profitable big retailer listed on the London Stock Exchange.
Will I buy the shares today?
Next ticks a lot of boxes for me as a potential investment. As well as being a top-quality retailer (in my view), it also has a solid track record of dividends.
The ordinary payout has risen from 41p per share in 2005 to 233p per share last year. Shareholders have also benefitted from share buybacks and one-off special dividends over the years.
Buybacks can boost future earnings per share and support dividend growth. But unlike many companies, Next doesn’t want to overpay for its own shares. The company has a clear affordability test requiring a minimum expected return of 8% on buybacks.
Right now, the shares don’t pass that test. Based on today’s upgraded profit guidance, the maximum Next can pay for its own shares is £116. That’s 7% below the current share price of £124.
Next shares are starting to look expensive to me on other measures too. The forecast price-to-earnings (P/E) ratio of 18 is at the top end of the retailer’s historic valuation range, according to my research.
With the cost of living still high and the UK economy under pressure, I don’t think it makes sense to pay a top price for Next shares.
I’d prefer to have a bigger margin of safety, so I’ll be waiting – at least – until Next itself is happy to buy its own shares.
