Next shares are trading up 8% this morning as the retailer posted sales up 3.8% in the six months to the end of July 2018, and it revealed detailed plans of its preparations for a no-deal Brexit.
During the period the bellwether retailer achieved total group sales up 3.8% to £1.986bn with a pre-tax profit of £311.1m (up 0.5%). Retail sales were down -6.9% to £925.1m while online was up 16.8% at £892.3m. Sales from its finance division were up 12.5% at £122m.
The increase in the share price was driven in particular by news that the business had upped its full year profit before tax by +£10m to £727m. Next had assumed in its last trading statement that there was a high risk that a jump in sales July would be offset by a drop in sales in August but in the event it transpired that the business did not experience any material loss in sales in August or early September.
As ever, though, Next CEO Lord Wolfson was careful to manage expectations for the second half. “The UK retail market remains volatile, subject to powerful structural and cyclical changes. Many of these headwinds have not abated. As expected, sales in our stores (which now account for just under half of our turnover) continue to be challenging.
“We believe the over-performance in the first half was flattered by the unusually warm summer and we remain cautious in our outlook for the rest of the year,” Wolfson said.
In an unusually detailed update, the retailer outlined its future planning to deal with the increasing shift from offline to online retail and its plans for a “no deal” Brexit scenario,
Wolfson said its discipled approach to retail, such as agreeing to relatively short-term leases and investing in profitable space, has meant that its stores are still profitable and robust despite declining sales.
“The overarching story centres on the profound and rapid structural change in our sector, with ever increasing volumes of sales transferring online. It is worth reflecting that 10 years ago Next Retail contributed £2.2bn turnover to the Group and accounted for 67% of Group sales and profit. This year we expect Retail sales, at just under £2bn, to contribute less than half of our Group sales and only 30% of Group profit,” Wolfson explained.
“The fact that our Retail sales have only fallen by 10% in a period where like-for-like sales declined by 32% is because we have continued to invest in profitable new space. The disciplines we have imposed on this investment programme have stood us in good stead. Relatively short lease terms, high profitability hurdles, rigorous depreciation policies and a two year payback hurdle on capital invested, collectively mean that our Retail portfolio remains very profitable and our lease commitments relatively light,” he added.
Moving forward he said the business would continue to rigorously control its costs and “we must ensure that we take maximum advantage of the many lease expiries we will experience over the next few years. Our aim is to manage rent levels and new lease terms to match today’s levels of trade and volatility.” More importantly Next would also further integrate its store with its online business, he said.
Wolfson, who was a prominent figure in the pro-Brexit movement, also detailed the retailer’s plans for no-deal Brexit scenario. He said he did not believe a no-deal scenario would pose a material threat to the business but stressed this was due to the detailed preparations and scenario planning the business had undertaken, which he said should not be underestimated.
“It appears to us that it would be in the interest of both the UK and remaining EU nations that the UK’s departure from the EU is carefully managed, accompanied by a period of transition and some form of agreement for free trade,” he said.
To mitigate any issues arising from a no-deal Next has set up a dedicated business in Germany (it already has a warehouse in Germany from which many of its EU orders are fulfilled) to avoid the issue of potential “double duty” being applied to goods sold from its UK website to EU customers and being returned to the UK. And to avoid EU customers paying duty on the sale price rather than the cost price.
“It is likely goods would be sold to our German company from our UK company. Goods would then be deemed to have been imported into the EU by our German company at cost plus a reasonable transfer premium, in the same way as if they had been imported direct from the overseas territory in which they were manufactured.
“It is our intention to bond our German warehouse facility so that goods will only incur duty when they leave it and go into free circulation in the EU. This will enable unsold goods that return from Germany to the UK to avoid double duty,” Next said.
The business played down the potential of increased duties, and therefore potential increased prices in store, on goods coming in from countries such as Tunisia, Morocco and Mauritius which have free trade agreements with the EU, saying these only accounted for 3% of its imports. Most of its stock comes from countries where there would be no change to duties, while 10% of its stock is sourced within the EU and Turkey, which has a customs agreement with the EU.
It therefore estimates that there would be a maximum additional increase in the cost of goods of around £20m, which would add less than +0.5% to its prices at most.
However the business said there was a real risk of disruption to deliveries should there be delays at British ports, and that such as scenario would present the biggest no-deal Brexit risk to its business. It called upon the Government to provide greater clarity and reassurance on the matter and issued a statement outlining its proposed solutions.
“It appears that most of the measures under discussion to ensure smooth operation of our ports post-Brexit are designed to perform the same procedures as currently undertaken for non-EU imports but in much greater volume.
It would be helpful to know if the Government are also considering changing some current customs practices, procedures and rules in such a way as to speed up the processing of in-bound traffic. The Government may consider the following measures that we believe would reduce the volume of work required at our ports and airports:
- – Temporarily raising import thresholds for goods bought into the UK by small importers so that they avoid customs procedures
- - Implement the kind of self-assessment tax procedures for customs tariffs and duties that mirror other UK taxes such as VAT. The Government trusts businesses to collect £125bn of VAT through self-assessment, so it would seem reasonable to trust them also to collect £3.5bn of Duty in the same way. We believe that this would push much of the administrative burden back from the points of entry to UK and do much to alleviate pressure on UK ports
- - Extend temporary Trusted Trader (or Authorised Economic Operator) status to many more importers through a simplified and less burdensome application and certification process. This status allows certain checks on vehicles, drivers and customs classifications to take place inland or at a later date rather than at ports.
The earlier that these or other measures are communicated to the business community the more likely they are to be successfully implemented,” the company said.
Analysts responding positively to Next’s announcement and in particular its detailed Brexit planning. “In a first from the UK high street, Next said it was well prepared for Brexit, even if it is a no-deal hard Brexit. It is the first major UK retailer to do so, demonstrating that those shops that mean to survive the tumult of Brexit will have to do some considerable groundwork.
“Next shares jumped 8.3% in early trade beating all other stocks for the lead riser position. Other retailers will take note of this and the importance the market is placing on transparent, hard Brexit contingency plans. Some retailers have been far too nebulous in this respect,” said Fiona Cincotta, a senior market analyst at www.cityindex.co.uk.