The UK retail sector has had a challenging couple of decades, with the growth of online retail in particular putting the high street under severe pressure. A number of brands – both large and small – have gone bust, but this can create opportunities for profitable businesses that can grow their market share.
Next is one such business. Founded in 1864 in Leeds, it has become the largest clothing retailer in the UK, despite never being known as an especially cutting edge player in the world of fashion. For investors, the numbers it produces are fit for the catwalk. Historically, Next had a large directory business, which was a catalogue business where people ordered through the mail. This in turn helped the business shift online more easily than others.
Focusing on profits
Compounding this is Next’s well-invested infrastructure estate. The company has over 500 stores in the UK and Ireland, but crucially, it hasn’t made the mistake that has sunk many other retailers: overexpansion. Instead, Next has kept its estate in very profitable locations with short leases.
Being the UK’s number one gives Next huge economies of scale, enabling it to sell products more profitably than competitors. Its position also delivers another quality attribute: barriers to entry. Intuitively, one might not associate retail with high barriers to entry because it's relatively easy to start a brand and sell a product. However, it's very difficult to do this profitably.
Being ahead of the curve
Next very quickly understood that the growth of an online marketplace would introduce more brands, products and threats to its own business. In response, Next turned this into an opportunity, selling some of these new brands through its own platform in the late 2000s. Third-party brands now contribute about £1 billion of sales, about one-fifth of total revenue, and we believe this is a huge opportunity in the future.
Part of that business is using a traditional wholesale and commission-based model. However, another part is using what Next calls ‘Total Platform’, offering third-party brands access to the retailer's online logistics and back-end systems – essentially providing end-to-end online infrastructure. The brand owner can design some products and then Next does the rest, ranging from the website, taking payments, the warehousing through to the delivery. This enables the third-party brand to scale up very quickly and profitably without needing much upfront capital investment.
Resilience through cycles
Next realised that its Total Platform offer was so compelling that it wanted to share in some of the profits. Therefore, in recent years Next has started taking small equity stakes, or buying famous but struggling brands, embedding their infrastructure and scaling profitably. In recent years, Next has bought distressed stakes in Reiss, Jojo Maman Bebe and Made.com, helping produce this additional avenue for growth.
While all retailers are subject to demand cycles, Next has been far more resilient than most of its peers through challenging markets and that's partly because of its business model. Next is run conservatively with a very strong balance sheet and a small, profitable, store estate. Management is ruthlessly focused on delivering an attractive return on invested capital – currently over 20%, well above the industry average – and this filters through the entire business, from allocating capital to stores through to determining how much cash to return to shareholders.
A bright future awaits
Crucially, Next’s product set is more resilient than some more fashion-forward trend-led peers. A high proportion of sales come from childrenswear, for example, which tends to be a repeat purchase (albeit a size up) regardless of the economic cycle.
Next’s future looks bright, in our view. The retail business is now only a small part of the company, its market leading online business is well positioned, and third-party brands are scaling through Next’s infrastructure. The company is also growing overseas successfully, offering another avenue for future growth. Next has a number of profitable routes to market and we are confident that the management team will pivot the business to whichever of those offers the best opportunity.
