Next Should Lead MandS UK Retailers on Investment and Store Plans

(Bloomberg Gadfly) -- Next Plc has delivered a modicum of relief to the high street. While it's battling a worsening consumer outlook and has some problems to tackle, its biggest rival is in the same boat. And Next has a stronger paddle.

The British retailer kept its profit forecast intact despite worse-than-expected sales, thanks to extra cost savings. But the disclosure that sales progress at the previously fast-growing Next Directory arm ground to a halt in the past three months is worrying -- it accounts for about 40 percent of group revenue.

Nimble rivals such as Asos Plc and Boohoo.com Plc are nipping at its heels, and even fusty retailers such as Marks & Spencer Group Plc and Debenhams Plc are making progress online. Simon Wolfson, chief executive of Next, says keeping Directory ahead in the U.K. will be a battle from here.

The hiccup in Directory, which covers its online and catalog sales, comes against a challenging consumer backdrop, one that could well become more difficult. Consumers don't love fashion as much as they used to, and the weaker pound is set to feed through into higher sourcing costs. Next says it may raise prices by as much as 5 percent next year, a tricky proposition when consumers have got used to perpetual discounting and their spending power is set to come under pressure.

Next Directory 3Q sales growth:

0%

Steve Rowe, the new chief executive of M&S, will unveil his new strategy next week alongside sales and profit reports. He may scale back M&S's international operations, including closing its flagship Paris department store, and shrink the U.K. store base, a move that is much needed as its sales report may be subdued.

But Next has already got there, under Wolfson. It's been proactively managing its British estate for some years, moving from smaller outlets to out-of-town department stores. Similarly, it's already recognized that Directory is losing its edge, and is investing in better stock availability, improving its mobile site and personalization.

It probably should have tackled this earlier. That's a rare misstep for a company that's otherwise been well managed. Still, its years of being ahead in the online game mean Directory is still a better offering than M&S and Debenhams -- though the gap has certainly narrowed. It needs work, but nothing like the radical surgery needed for M&S.

Concerns about Directory have taken their toll on Next's valuation, and shares have fallen about 37 percent over the past year. This has gone too far. It's had better clothing and home furnishings sales growth in recent years than M&S. On a price to earnings basis, Next should be leading the U.K. clothing retail pack, instead of lagging M&S.

For all the challenges, Next's stable management, and strong balance sheet -- it generated 430 million pounds ($527.6 million) of free cash flow last year and Wolfson says it will be strongly cash generative again this year -- mean that it is still best placed to ride out the brewing storm.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Andrea Felsted in London at afelsted@bloomberg.net.

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.