Write a business report of your FR unit leader analysing the financial performance and position of NEXT plc for the year ended 24th January 2015 compared to the previous year. For this assignment assume the role of a financial analyst.
NEXT Plc is a leading retailer of UK, specializing in exquisite and trendy apparel, shoes and fashion accessories for men and women. The retailer is also widely known for its home interior products. NEXT’s important segments include NEXT Retail, NEXT Directory and NEXT International Retail.
NEXT Retail is a large chain of more than 500 stores in the UK and Eire. The segment contributes almost 60% of the group revenue. NEXT Directory is the home shopping division with more than 4 million customers in the UK and overseas. The segment has grown by over 150% in the last decade and accounts for 40% of the group’s revenue. NEXT International Retail comprises of nearly 200 franchised stores and contributes nearly 2% of the group revenue.
NEXT Sourcing is involved in the strategizing, sourcing and acquisitions of NEXT branded products.
Lipsy deals with the designing and sale of Lipsy branded younger women’s fashion products with nearly 40 stores, online, and wholesale and franchise channels. The segment contributes around 2% of the group revenue.
Analysis of the financial performance
Working capital serves as the best measure to gauge a company’s short-term well-being and efficiency. Net working capital is arrived at after deducting the current liabilities from the current assets and helps us understand that whether the company’s short-term assets are enough to take care of the day-to-day running of the business. NEXT has maintained a net working capital turnover of 12.4 and 13 in FY15 and FY14, respectively, which is pretty decent. NEXT’s gross profit margin has remained pretty stable at ~33%. The gross profit of the company was £1.3 billion while the cost of sales was £2.6 billion in FY15, and £1.2 billion and £2.5 million, respectively in FY14. Therefore, the retailer needs to improve its cost of sales which is eating away more than 66% of its revenue of £4 billion in FY15 against £3.7 billion in the previous fiscal. NEXT needs to restructure its purchasing policies and inventory management approach. NEXT should aim towards increasing its sales volumes, keeping the costs under control, ensuring better profitability and lower cost to sales ratio. After all the record sales figures hold no value if the cost of sales are consuming more than 60% of the revenue and leaves back nothing for the company.
The operating profit margin is the best indicator of the effectiveness of the administrative costs over sales. The growth of more than 12% in the y/y operating profit bears testimony to the fact that the retailer has been able to control its selling and administrative costs to some extent, thereby helping it to maintain a consistent operating profit margin of 20%. The fiscal witnessed an additional profit of £57 million from new retail space, existing stores and additional online sales. Cost curtailment, savings and other group profits contributed another £30 million. The cumulative result of which was a y/y growth of 12.5% in Profit before tax and exceptional items to £782 million. However, we can see that the company’s operating costs relative to its operating profit is 67% in FY15 and needs to be controlled by bringing down the cost to sales ratio. Hence, the company can resort to better energy efficient machinery and better management techniques for cost reduction.
Net profit margin enables outsiders to determine the effectiveness of the operations of the company and profitability of the various segments in the business. Therefore analysis via net profit helps the investors or creditors to understand how the company is performing relative to its cost of operations. The net profit margin has been consistently increasing over the last 5 years. The net profit of £635 million in FY15 has posted a y/y growth of ~13%.
The NEXT Directory results were mainly triggered off by the growth of over 8% and 61% sales in UK and overseas online sales, respectively. It witnessed a growth of over 11% in its active customer base in FY15. Consistent increase in Next and franchise stores have contributed hugely towards the improved margins.
Thus, it contributed to a very healthy bottom-line with a y/y growth of 12.5%. The retailer has maintained immense consistency in its net margin growth over the last 5 years, with a growth of 38%. The retailer has successfully cut down on its raw material costs as well as store costs on one hand, while it has also managed to estimate its future sales leading to excellent inventory management.
However, there is even further scope for improvement through innovative supply chain management and technology leading to minimisation of wastes. Costs could also be brought down further and better marketing techniques could be adopted leading to improved sales volumes and better pricing strategies.
Return on capital employed assumes immense importance in determining the efficiency of the firm relative to the investment in the company. Therefore, every company strives for a higher return. NEXT’s ROCE for FY15 was 58% versus 55% in the previous fiscal. The retailer has always maintained a Return on Capital Employed of over the 50% mark in the last 5 years which clearly denotes the efficient utilization of funds. The company has also maintained a Return on Equity of more than 230% over the last 5 years which is phenomenal and speaks lengths as to the efficient utilization of resources.
Analysis of financial position
The current ratio and the quick ratio are the key determinants of the financial well-being of the company. They go a long way in determining that whether a company will be able to honor its day-to-day financial obligations or not. Investors and creditors therefore hugely rely on the liquidity ratios before taking any decision. Ideally they expect a current ratio of greater than one, which signifies positive cash flows.
NEXT Plc’s current ratio has been steadily increasing over the last 5 years. A current ratio of 1.82 in FY15 and 1.76 in the last fiscal reflect a very strong liquidity position of the company. The retailer has managed to maintain a current ratio of more than 1.20 over the past 5 years which has further consolidated the position of the company. Further the quick ratio of 1.34 and cash ratio of 0.38 clearly shows that NEXT Plc is adequately cushioned with cash and liquid assets to take care of the creditors. The quick ratio scores brownie points in determining the liquidity of the company as this ratio only considers the most liquid assets which are fastest converted into cash. The ratio excludes inventories from its calculation and we can see the consistency maintained by the company in its quick ratio, which was 1.30 in the last fiscal and has consistently shown an upward trend in the last 5 years. Summing up, we can assume that the company has a commanding liquidity base.However, it has also raised a question in the mind of analysts as to why the retailer is stacking up its cash base, which exactly is not reaping any returns.
Every company strives for a lower average collection period and a longer average payment period. Unfortunately for NEXT, both the periods are too long. Despite such strong cash position, the average collection period of debtors of 75 days in FY15 and 74 days in the past fiscal is reflective of inefficient debt collection management. Same is the situation in case of average payment period of creditors of 84 and 82 day, respectively for the same periods. Unconditionally long collection periods are associated with higher chances of bad debts and purchasing power loss during inflation. At the same time, obnoxious long payment periods may deter potential creditors who opt for short period payments. Therefore, NEXT needs to attain a fine balance between the two and bring down its cash conversion cycle of 46 days in FY15 and 44 days in the past fiscal. Unless the company starts restructuring its cash flows, it may face problems during periods of stagnation and recession.
The debt ratios play a very crucial role in determining the long term stability and sustainability of the company. The company is highly leveraged, which again is a cause of concern. A debt-equity of 261% in 2015 does leave the retailer in a very risky position. The company gets overburdened by high interest costs which eat away a significant part of the company profits. Long term debt comprise of more than 70% of the company’s capital. Though the company has a flattering cash base but we need to keep in mind that it is meant to cover the day to day operations. The company’s interest coverage ratio of ~26 is not adequate enough considering the high leverage of the company and can pose serious problems during recessionary or stagnating phases. It can signal liquidation during stagnation or recessionary phase. However, on the brighter side we can see that the company has been able to reduce its net interest expenses over the years from £0.71 million in FY11 to £0.43 million in the present fiscal. The high debt ratio is a precursor to the danger that the company might be subjected to.NEXT Plc should consider revising its capital structure by focusing on increasing its equity and retained earnings.
The retailer’s fixed asset turnover ratio of 7.95 and 7.34, respectively for FY15 and FY14, reflect efficient utilization of assets. Same can be said about the total asset turnover of 1.75 and 1.74 for the same periods, respectively.
The company has been able to bring down its capital expenditure as a percentage of sales over the years which have improved the cash flow from operations significantly. As a result the company’s free cash flow as a percentage of sales and net profit has also improved over the years. Free cash flow (or the cash flow available to the company after expending off the money required to expand and maintain the company’s assets), as a percentage of sales has increased from ~14% in the last fiscal to about 16% in the present fiscal. Free cash flow as a percentage of capital expenditure has also dipped over the years and has remained below 3% in the trailing 3 years. The company’s free cash flow to net income ratio has increased from 0.92 to 1.0 in the present fiscal.
Finally, the company’s price to earnings ratio, which is extensively studied by investors and creditors for valuation of a company, has remained pretty stable at ~16 over the last 2 years which is a good sign. It can be improved further once the company starts issuing more shares, thereby raising the market capitalization and simultaneously make serious efforts to further improvise its earnings figures.
Limitations of Financial Statement and Ratio Analysis
Though ratios provide with an insight into the company’s performance and position, they do not make complete sense on an absolute basis. They need to be compared with the industry average and other similar companies in the same or similar sector. Here lies the limitation as different companies have their different methodologies in terms of recording, accounting and valuation. Even the industry figures may not reflect the true position all the time.The historical data or the forecasted data on which the ratios are based may not be truly reflective of the future which will always remain uncertain and unpredictable.
The principles of recording items in the income statement and the balance sheet are different. The income statement items are recorded at their current cost, while some of the balance sheet items are recorded at historical costs resulting in discrepancies.Seasonal factors like high level of inventory during summer may not reflect the true position of a company.
External factors like inflation may cause discrepancies in the ratio and may make it difficult for the outsiders to gauge the actual position of the company.
The ratio analysis is also rendered ineffective in case of companies with different strategies. A company with a low cost strategy cannot be compared with a company concentrating on a customer service strategy.
The ratios may not always be reflective of the true position of the company. For example a company with a strong cash ratio, which is considered as an USP, may also symbolize the fact that it is no longer a growth company.Sometimes a mixture of good ratios and bad ratios render it difficult for the outsiders to value a company properly.
After analyzing the financial statements and ratios we can infer that the company has very good and promising fundamentals. The strong liquidity base of the company, backed by increasing efficiency in utilization of its capital and assets has cemented the company’s position way above its peers. However, at the same time, the company should also focus towards striking a balance between its highly leveraged capital structures. The company should also further concentrate towards its credit collection and payment periods to improve its cash flows further. NEXT should start preparing itself beforehand to weather off the bad economic phases to keep itself at least at par, if not ahead of its peers.
The retailer has recently repurchased shares valued £10 million for the seventh time after the share value dropped due to a disappointing Christmas season, thereby the repurchase value aggregating to £140 million. The company was also held guilty of breaching the Companies Act while paying special dividends. However, the NEXT has assured that the company is pretty confident that the payment of dividends will not affect the prospects of the company.The company’s strong cash flows and the chilly weather of January are the two most important criteria that are being bet on.
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