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Is NEXTs Share Price Offering at 50% OFF

Presents Value Buying Opportunity?

So, not only is NEXT PLC offering a 50% discount to its


customers, but its share price fell by more than 50% to
38/share from 80/share during 16 months. The REAL question
is:
Does NEXT PLC shares represent a bargain like their clothing
line or are we bracing for further reductions ahead?

A Quick Glance of Next PLC


Looking at NEXT PLCs fundamentals, it has operating margins at
20%* portrays a healthy retailer with decent margins that is higher
than hot retailers like BOOHOO and ASOS of which its margins are
between 4% and 7%, respectively.
These online retailers are growing faster than NEXT meaning future
profits and margins will likely increase faster.
However, the PEG Ratio (keeps track of changing market value and
earnings growth) put NEXT on 0.61, compared with BOOHOOs 0.93
and ASOSs 5.04 meaning the market places higher value to these
online retailers profits than NEXT, despite having lower operating
margins!
*NEXTs operating margins have never been below 10% (going back
to 1999)!
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On the other side of the spectrum, luxury retailers like Burberry,
LVMH and Hermes have more say on Pricing, therefore it can
command higher operating margins. This is down to the power of
their brand names projecting fashion status and social status (or, it
could be the quality garments it produces). At the high-end of the
fashion segment, NEXT beats Burberrys operating margin of 17%,
and are not far behind LVMH and Hermes.
These luxury retail stocks command higher P/S and P/E numbers
than NEXT!

Does the straightforward and quick research proves


NEXT PLC is a bargain for value investors?
Am no expert in the day-to-day running a clothing
business, thats for people like Philip Green and Mike
Ashley. But, I do know how to analyse a retailers
financials. And like any retailers, it needs to grow
profits and generate cash.
Below, are the following factors you need to know about
NEXT PLC:
A. NEXT PLC earnings power, which includes the
subsequent cash flow analysis;
B. A breakdown of NEXTs revenue breakdown, and
why there is a surprise in its directory division.
C. A simplify, but useful analysis of NEXT PLCs
market and enterprise value in proportion to
various financial metrics, including KPIs measures.
D. For those short to medium-term traders, a useful
breakdown of NEXTs technical analysis share price
chart.

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E. Finally, an evaluation and likely direction of NEXT
PLCs share price in the medium-term, including a
brief summary.

The Earning Power of NEXT PLC


The earning power of NEXT is almost Unmatched, compared to
its rivals. Here is what I mean:
In 2016, the retailer produced 469m in free cash flow. If they
decide to cancel dividends and buybacks for one year, it would
save 811m. NEXTs cash balance would swell to 740m and
nearly covers its total debt (NEXTs total debt and cash balance
in 2015 is 841m and 275.5m, respectively).
In a different angle, NEXTs free cash generation can pay off
55% of total debt and it also covers interest costs at 15X over.
Moreover, since 1999, NEXTs free cash flow generation totals
over 5.6bn, but it also paid out 6.8bn to shareholders.
Furthermore, the number of share issue declined by 65% to
150m from 370m, which adds to the company as a legitimate
retailer not manipulating its accounting profits.

Analysing NEXTs cash flow statement


As mentioned earlier, NEXT produced a total of 5.6bn in free
cash flow since 1999, while not recorded a single negative
FCFs figure in the period. In the last five years, NEXT average
free cash flow amount to 530m per year.
NEXTs net cash flow from financing (bottom of the cash flow
statement) is a sign of strength, despite its negative subtotals
for the last 16 years. It means management were busy returning
cash to shareholders and was willing to take on some debt (to
the tune of 1bn) because its earnings power allow it this
privilege.

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NEXTs Secret Weapon
Before we reveal the companys secret weapon, let us
breakdown the firms two distinct divisions, its online directory
and Stores division.

Source: NEXTs annual reports.


Its online division grew faster and that translates to a compound
rate of 11.4%, compared to 6.5% in their store division.
Moreover, its online earnings have surpassed its retail earnings
for the first time!

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With a lower sales figure, that means NEXTs online division
achieved net margins of 24%-25%, higher than its reported net
margin of 15%. Curiously, the net margin made by established
online retailer, ASOS is 3% with BOOHOO tagging along at 6%!

The secret sauce revealed


If you think NEXT had managed to source from cheaper
suppliers like retailer Primark and selling it at Marks & Spencer
prices, then you are deeply mistaken. The secret to NEXTs
earnings success is the firms credit services (store credit card).
In 2015, NEXT manages to bank 170m interest fees, making up
ONE-THIRD of total profits and 50% of total online earnings.
This is not surprising because, although a typical credit card fee
is 18%-20% APR from the bank, NEXT charged close to 25%
APR!

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Source: NEXTs annual reports.
The growth in NEXTs interest income from its credit services
look big, but it has been declining as more shoppers were
shopping online. It explains why earnings growth in its retail
division has stalled.
As long as NEXT remains fashionable and customers remain
online, their credit card business would prove lucrative.
However, if a normal recession occurs, when consumers feel the
need to save and not spend, or choose cash, instead of credit,
then NEXT (along with the whole service sector) will feel the
pinch.
You would think NEXT is charging exorbitantly higher rates
than other general retailers, but see below:

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P.S. Only Topshop and M&S charge less than NEXT PLC.

Key Performance Indicators and Market Valuation


Did you know NEXT PLC consistently achieved negative like-
for-like sales in eight out of ten years? Me neither.

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Source: NEXTs annual reports.
Nobody raised any alarm bells to this phenomenon, but how is it
possible that the firm were increasing its profits margins year-
after-year without improvement in the efficiency of its stores. It
perfectly accompanies the fact it is gobbling up retail space at an
alarming pace (RED LINE) with revenue per Sq. Ft declining.

Source: NEXTs annual reports.


So, if there are any readers, please explain why this is possible?

Spotting the historical trend


Some investment websites analysed stocks by looking back at
the companys results for the last three years. It is typically
unhelpful to their readers because short period analysis excludes
the business cycle trend where shareholders want to know if the
business is sustainable.

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The solution is to review a companys performance over 10, 15
or 20 years helping to paint a clear picture of the business cycle
from peak to trough. Also, we can assess how a company,
fundamentally reacts to a recession. This all-round research is
useful for a retail investor looking for that historical trends and
spotting that opportunity to invest at the right time.

NEXTs Historical Valuation Trend

Earnings yield
A reciprocal of the PE Ratio, the earnings yield paints a picture
of NEXT tussle with market sentiment versus operational
performance. The current earnings yield averages 8.37%, based
on the average share price of 55.84/share in 2016.
Next year, earnings expect to fall by 3.4% to 644m. With the
current share price of 39/share making the earnings yield rise
to 11.3%.

Source: NEXTs annual reports.

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Given that NEXT average earnings yield is 7.61%, then you
would think 11.3% is a bargain? In a historical context, NEXTs
earnings yield reached 16% during financial crisis of 2008/09,
though at one point it touched 20%!

EV/EBIT
On an enterprise value to earnings basis, NEXT is 7.75 times, the
lowest since 2008/09 and below its 18-year historical trend of
10.9 times, that same metric, two years ago, was at 15 times!

Explaining Earnings Yield and EV/EBIT Trend


So, why both these metrics are trading below historical averages
when the business fundamentals have slightly deteriorated?

One important factor to remember is the future of E in these


ratios! NEXTs management warned that earnings would come
in below guidance. Here are the following quotes from
management:
We may see a further squeeze in general spending as inflation
begins to erode real earnings growth.
As previously indicated, following the devaluation of the
Pound, we expect prices on like-for-like garments to rise, but by
no more than 5%. We expect that this will depress sales
revenue by around 0.5%.
Furthermore, management expects a 29m rise in costs for the
following reasons:
A. National Living Wage;
B. Energy taxes;
C. Wage Inflation;
D. Website improvements.

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All this means profits before tax range from 680m to 780m,
which translate to a decline of -14% to -2% from previous year
result. By putting this in a historical perspective NEXTs shares
fell from 19/share to as low as 6.17/share, a drop of 67%, when
net income declined by 18% from 354m to 302m in 2008/09.
Sales are not vanity when in pursuit of a trend
Using EV/Sales and P/S, we get this chart:

Source: NEXTs annual reports.


Not surprisingly, NEXT is close to its historical average,
regarding their sales valuation. The current EV/SALES and P/S
range between 1.5 and 1.6 times, the worse reading since 2011.

Explaining NEXTs historical share price adjustments

The change in NEXTs share price is affected by the retailer


ability to reduce their share count (number of shares in issue),
this effect the whole share price dynamic.

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For instance, NEXT average share price in 2000 was
6.22/share, but when adjusted for the fewer shares in issue it is
equivalent to 15.46/share. Below a table shows the change in
NEXTs share price adjusted and unadjusted:

Source: Finance.Yahoo.com.
Notice that at an adjusted basis, NEXTs share price in 2008 is
lower than it was back in 2000 meaning if today share price
was to drop to 20/share it could be cheap on a historical
context.
Therefore, THINK MARKET VALUATION, not SHARE PRICE!!
P.S. The above example should be taken into context that
NEXTs operations experience a temporary setback, which is
EASILY fixable!

Share Price Forecast for NEXT PLC


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The short-term share price projection

With limited technical analysis skills at hand, the technical chart


is alerting you to a possible divergence pattern in NEXTs
share price and convergence patterns in two famous
momentum indicators in the MACD and RSI.
For the above to occur, NEXTs share price need to close below
35.5/share (its BREXIT low point) and, provided the
momentum indicators do not make new lows!
Therefore, I recommend a BUY on NEXTs share price between
33 and 35/share.
Why?
Because, the momentum indicators would likely see its
convergence pattern intact, if not, DO NOT get into this trade!
The target sell price is 45-47/share, a 30% upside.
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P.S. Follow the 50 days simple moving average trend line, as
NEXT fails to break above it twice meaning the continuation of
its downtrend.

NEXTs medium and long-term share price prediction Using


Macro Factors
This is harder to predict because of uncertainties surrounding its
future earnings. However, I come to the conclusion that any
short-term spike in its share price will be short-lived because
fundamentals remain weak. Factors affecting NEXT future
earnings are:
1. Inflation spike due to the weak GBP; - Necessities like food
and energy costs spike, therefore non-essentials like clothing
will come under pressure. So, it shouldnt surprise you if NEXT
lower forecast earnings again.
2. Bank of England raising interest rate; - this probability is low
if inflation rate spike is temporary, but if inflation is persistently
high, then rates could go up.
This action would tighten household budgets further due to
RISING mortgage costs.
3. Will higher inflation leads to higher wages; - Inflation can be
offset if employees get a wage increase equal to or greater than
the inflation increase, therefore stabilising various sectors of the
economy.

Therefore, despite NEXTs competitive advantages my forecast


of NEXTs shares would trade at 30 per share in a years time.
However, at that level it represents a bargain for investors, but
only if NEXT manages to sustain net income of 550m or more.

I could be wrong in this forecast, but I could be very right.

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Summary
1. NEXT PLC share price fell by more than 50% in the past 15-16
months.
2. NEXT PLC current operating margin is 20%, but likely to fall
this year. However, since 1999 it never went below 10%!
3. NEXTs PEG ratio stands at 0.61, which lower than BOOHOOs
0.93 and ASOSs 5.04.
4. The retailers online division has operating margins at 25%
helped by interest income fees, which accounts for 50% of
online earnings and 33% of total group earnings.
5. In the companys retail division its revenue per SQ. Ft.
declined from 1,000 to 650, while tripling in sizes.
6. 2017s profit before tax guidance is between 680m to 780m,
which is -14% to -2% lower than 2016.

Disclosure
The opinions are expressed independently by the writer for
entertainment and research purposes and not taken as
investment advice. Data is correct on available information at
the time.
Finally, the writer does not own the companys stock, unless
stated otherwise.

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http://walbrockresearch.com/home/.

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https://twitter.com/Wh_biz32.

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Is NEXTs Share Price Offering at 50%
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