If you are searching for insight into the current retailing landscape, you need to look no further than Next’s latest half year results (to July 2018). Ten years’ ago, Next Retail (physical stores) contributed £2.2bn to the group, 67% of sales and profits. Today, sales are under £2bn and contribute just under 30% of profit.
Over the same period, Next’s online platform has grown at 10% per annum, increasing turnover from £816m to £2.1bn. Overseas online business now accounts for 30% of online sales too.
In a highly competitive environment, Next appear to be adapting well to the change in their business. Despite the switch to online, physical space remains important and Next are forecasting a net increase of 42,000 sq ft in their retail portfolio in 2018. They have closed 22 stores to date but have continued to expand and open new stores elsewhere. However, they are looking for value and are negotiating aggressively with landlords. In 2018, 33 of their stores have expiries and where they decide to continue trading, the average rent reduction is a significant 32%.
Next’s approach to lease renewals is that they will renew a lease in any of the three following circumstances: -
- A store is highly profitable (e.g. making greater than 20% branch profit and the lease commitment is not too onerous, i.e. up to 5 years).
- Where store profitability is low (e.g. 5-20%) but the renewal period is very short (i.e. 6-48 months).
- Where store profitability is low (under 15%) and the landlord is content for Next to hold over at the existing or reduced rent. Holding over means that both parties have the option to determine the lease at will so that, effectively, Next could vacate at any time.
Another feature of the physical estate is the number of concessions now operated within stores. These amount to 164 comprising cafes, travel operators, card and stationery shops. In 2018 Next expect to grow concession income from £8m to £11.5m with concessions representing 3.7% of total trading space.
Next’s ability to deliver a true multi-channel offer is reflected by the fact that 50% of all UK online orders are fulfilled through their shops using a same-day click and collect service.
It is not just the retail estate where there is a strong focus on margin improvement and cost management. This is evident in all aspects of Next’s business with considerable investment forecast in the warehouse estate amounting to £200m over the next three years. Next operate from only five warehouses but following investment in a sophisticated automated storage and retrieval systems, together with a forward picking system, Next expect to increase online sales capacity by 75% and add £1.5bn to online sales.
At Mayfair Capital, in the context of our investment strategy, we continue to be bearish on high street retail and capital expenditure-hungry shopping centres, but believe there may be some value in selected areas of the out-of-town warehouse market. However, across the whole sector, the shift towards shorter lease lengths represents a downside risk to rents in the current environment due to retailers’ ability to renegotiate the rental level rather than being subject to a traditional rent review provision in a longer-term lease.
Retailer and third-party operator demand for warehousing, however, continues unabated and our portfolios will continue to hold overweight positions in this sector. We do not expect our strategy to change for the foreseeable future.
CEO of Mayfair Capital Investment Management