Analysis of Next PLC PDF

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Summary

Analysis of the financial and governance of Next PLC including calculations and explanations....

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Assignment #2 Assigned Company: Next PLC

Module: Financial Analysis and Governance Module Code: AC6061

Word Count: 4061

Contents Executive Summary...............................................................................................................................2 Part 1: Corporate Transparency.............................................................................................................3 Internal Control Mechanisms.............................................................................................................3 The Board of Directors......................................................................................................................3 Remuneration and Audit Committee.................................................................................................4 Risk Assessment................................................................................................................................5 1

Control Activities...............................................................................................................................5 Information and Communication.......................................................................................................6 Part 2: Financial Analysis......................................................................................................................7 Performance and Return on Investment.............................................................................................7 Activity..............................................................................................................................................9 Liquidity.......................................................................................................................................... 10 Solvency.......................................................................................................................................... 11 Part 3: Suggested Future Development................................................................................................13 Organic Growth...............................................................................................................................13 Inorganic Growth.............................................................................................................................13

Executive Summary Next plc is a United Kingdom-based retailer offering discretionary clothing to males, females and also children. In addition to this, they also offer footwear, accessories and home products while recently also branching into the beauty industry. Next, operate over 500 stores between the UK and Ireland while also operating in a number of other EU and non-EU countries (Financial Times 2019).

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Being listed on the London Stock Exchange, Next plc has very impressive internal controls which add to the transparency and credibility of its reporting process. This is reflected in its strong financial performance and also through its impressive cost structure. While aspects pf Next plc’s financial position are positive, a number of recommendations can be made to further improve the position of the firm. Recommendations: 1. Improve efficiency in relation to the management of inventory and account receivables to reduce unnecessary costs. 2. Improve cash flow forecasts to ensure there are adequate resources available, a reduction in the cash cycle is also recommended to reduce unnecessary, unplanned borrowing. 3. A large proportion of next stores are on rented premises, this, in turn, increases the cost of operating, it is recommended that a number of properties are purchased, which in turn will increase the firm’s non-current assets while reducing the cost of renting in the long-run.

Part 1: Corporate Transparency Within any firm, corporate governance plays a vital role as it is essentially the structure and procedures for the direction and control of companies. In addition to this, it sets out the relationships between management, the Board of Directors, shareholders and other stakeholders. Basic elements of good corporate governance include transparency, accountability and also sustainability within the corporation and society. Corporate governance is an essential part of any business as it allows firms to operate more efficiently, 3

safeguard stakeholders and mitigate risks, keeping this in mind the corporate governance within Next plc will be assessed and evaluated to determine whether it is advisable to invest (O' Regan 2015) Internal Control Mechanisms In order to protect a company, internal controls must be in place for the purpose of adhering to legislation requirements and also to protect the company’s stakeholders and finances. Internal controls essentially set out processes of how to handle the operations of the business in an ethical manner. There is a number of reasons for instigating internal controls with the prevention of fraud and implementing procedures being the two main objectives. In doing so this, in turn, offers protection to stakeholders, including shareholders, lenders, creditors and also employees. The Board of Directors In harmony with the UK Corporate Governance Code, all directors must undergo performance evaluations which assess the performance of the board, in doing so, the aim is to assess and ensure all directors are working efficiently and are committed to their role within Next PLC. In 2019, Next conducted such evaluations and reinstated all directors to the board.

Another such control that Next PLC successfully adhered to is provision B.1.2 of the UK Corporate Governance Code which requires at least half of the board, excluding the chairman to comprise of non-executive directors determined by the board to be independent. On the Board of Directors in Next plc, four of the nine total members of the board are non-executive directors which demonstrate good transparency and credibility. Among the four nonexecutive directors, there is also one senior independent director, this allows a line of communication for major shareholders to voice concerns. It is also worth noting that four of the nine members of the board are female, exhibiting gender diversity.

The monitoring by directors, allows them to represent on behalf of the shareholders, by having internal controls in place it allows complete transparency and attempts to end any conflicts of interest. In doing so the positions of CEO and Chair of the board are held as separate roles as both roles have different objectives. The main aim of the CEO should be to manage the day to day operations of the company while in contrast, the chairman of the board’s main responsibility is to acts on behalf of the shareholders who are essentially the owners of the company. Without having such roles separate, there would be an opportunity 4

for a conflict of interest. As the above controls are evident within Next PLC, it is clear that there are adequate accountability and transparency.

Remuneration and Audit Committee Next plc’s remuneration committee consists of the Chairman and 4 other Independent Nonexecutive Directors, this allows for independent decision making. Both the executive directors and the CEO should not have the opportunity to influence their remuneration packages as it would give rise to a conflict of interest. As this directly applies to Next plc, it clearly demonstrates good internal control.

In an attempt to increase transparency and reduce fraudulent activities, 2015 saw the introduction of publicly listed companies being legally required to establish an audit committee. In line with Section 167 of the Companies Act 2014, Next plc’s audit committee consists of three non-executive directors with at least one director with relevant financial experience. By law, only one non-executive director is required, indicating that additional controls have been implemented by Next to increase the level of transparency and credibility of its reporting process.

Next plc strengthens the independence and integrity of its internal audit control function by ensuring that the internal auditor reports directly to the audit committee which allow independence of work. In addition, it is positive to see that the audit committee is active and meets with the external auditors which allows for their reporting to be credible, this too is achieved by the audit committee reporting to the external auditor. It is through the strengthening of the internal controls that Next’s audit committee also assist with mitigating the risk of fraud through regularly meetings and through the implementation of processes. Also, to reduce and manage risks, annual risk assessments are conducted by the board of directors. In 2019, one such risk addressed was the reliance on a small number of individual suppliers to maintain the competitiveness and quality supplied. By highlighting such risks to shareholders, Next plc has demonstrated increased transparency. As part of the COSO Framework, the Board of Directors and the audit committee contribute to an honest and ethical tone at the top. This tone cannot be achieved without good structure and independent reporting, which in turn demonstrates sufficient transparency and credibility within Next plc.

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Risk Assessment Brexit has created increasing uncertainty and risks having the potential to impact a number of existing operational risks within Next plc, including exchange rates and tariffs, regulatory changes and product availability. In order to reduce and protect against potential financial or reputational losses, Next has implemented internal controls that address any uncertainties or potential risks including warehousing distribution, customer experience, retail store network and financial, treasury, liquidity and credit risks. In order to reduce risk, Next plc operates a policy of continuous identification and review of principle risks. This allows both non-executive directors and senior management to be assigned the task of adapting processes to ensure appropriate risk management. In addition to this, the corporate compliance team is responsible for managing the day to day risk while also reporting to the audit committee. Half-yearly and annual reviews are also conducted to ensure risks are covered and assessed consistently across the business with the aim of reducing losses and protecting both the company’s reputation and stakeholders. This demonstrates the implementation of efficient internal controls which increase the transparency and credibility of the entity.

Control Activities Next plc measures its code of practice through its auditing standards, in doing so it ensures that policy is in place to increase their corporate social responsibility in relation to human rights and slavery, whistleblowing and anti-bribery. In a market which is saturated with slavery and poor working conditions, it is positive for any investor to see such policy in place. In an attempt to meet such a policy, Next conduct supplier audits to ensure standards are adhered to, this too applies to its sub-contractors. During 2019, the auditing function parted with 30 factories, 15 of which were due to slavery conditions. This exhibits Next’s setting procedures into practices which suggests increased accountability.

Information and Communication To achieve a credible and transparent reporting process, good internal controls in relation to information and communication must be of a high standard to allow objectives to be reached. As demonstrated by Next, there are good communication lines between a number of stakeholders including the Board of Directors, investors, the audit committee and also senior management. The Board of Directors communicates and gathers information regularly from

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investors through half-yearly and annual presentations, analyst reports and also through shareholder feedback reports. Once a regular flow of information is established between investors and the board, it may become easier for the board to communicate decisions. In order to keep shareholders satisfied and to maintain credibility and confidence, it is important to have clear and open communication. As Next plc have achieved good communication and information flows, this will evidently increase the transparency and credibility of both the financial and governance reporting process.

Part 2: Financial Analysis Performance and Return on Investment Over the last five years, Next plc’s performance has varied. With profit and sales at its highest in 2016, since, there has been a minor decreasing trend, much of which may be as a result of the highly competitive retail market as they also “continued to experience a structural change in our business, with sales continuing to transfer from our stores to online.” (Financial Times 2019) Due to the nature of the industry which Next plc operates in, people will always wear 7

clothes but as the economy experiences a downturn, there will be a decrease in revenue but as demonstrated by the below table, Next has the ability to recover from even the worst of economic events.

Financial Performance 2019 2018 2017 2016 Sales (£m) Profit (£m)

3917.1 3867.5 4,097.30 4,176.90 590.4 591.8 635.3 666.8

2015 3,999.8 0 634.9

In 2019, Next plc achieved a net profit margin of 19.45%, a slight decrease from 19.65% in 2018. This being the amount of profit that is extracted from total sales. This double-digit figure indicates impressive profitability for Next plc while also demonstrating good cost controls and adequate pricing of products. In comparison to one of its closest competitors, Marks & Spencer, who display a poor net profit margin of 1.56%, while online competitors ASOS also poorly display 1.28%. This demonstrates that within the competitive clothing industry, Next plc has satisfactory cost control and also adequate pricing which allows them to produce double-digit net profit margins. Similarly, a pre-tax profit margin of 18.45% means that for every pound, 18.45 cents remains with the company as profits before accounting for taxes.

While Next plc demonstrates the ability to generate just under 20% of its sales into profit, in 2019 it also turned investor’s capital into profits with a return on capital employed ratio of 52.22% in 2019 and 54.63% in 2018. Regardless of this figure having decreased slightly from the previous year, it is a very strong return. In comparison to M&S’s 2019 return on capital employed of 4.10% and ASOS’s 7.74%., Next plc clearly makes better use of its capital than its closest competitors.

To understand the extent of Next Plc’s performance, another ratio is the return on assets of the company. This ratio indicates the percentage of profit which Next plc earns in relation to its overall resources. With a return on assets of 44.93%, this indicates Next plc's efficient use of assets and the quality of these assets. In order to obtain such a high figure, the company must manage operating costs efficiently in order to maximise profit. Despite extra debt being issued in 2019, the ROA ratio has stayed relatively constant since 2018 with a figure of 44.32%. 8

Return to Shareholders Yahoo (2019) value Next plc at a whopping £9.6b which makes them an attractive investment for their value alone while the market capitalization is £8.782B. Another such attraction for investors is that they pay out both interim and final dividends which provide shareholders and potential investors certainty about the company's financial well-being. While Next pays dividends, it does so through having adequate profit and cash. As demonstrated in the below graph, dividends per share have been steadily increasing in line with yearly profits.

Dividends Paid per Share (Pence) in comparison to Profit for the Year (£m) 900 800 700 600 500 400 300 200 100 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

In 2019 Next Plc’s dividend payout ratio was 36.53% of profits for the year, this indicates that 36.53% of earnings are paid to shareholders as 63.47% of earnings are retained by Next plc to fuel its growth. While this is a favorable split, when making a comparison to the previous five years, this ratio was not as appetizing with a payout of 81.06% in 2018 and 85.11% in 2016. Dividend payment during those years was riskier as they consumed the majority of a company’s earnings, leaving little earnings for growth. One such explanation for the decrease in payout rate was due to Next buying back shares, which in turn reduced the total dividend paid.

2019 36.53

Dividend Payout % 2018 2017 2016 81.06 49.44 85.11

2015 68.42

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In January 2019, Next plc had the financial strength to pay out the current level of dividends 2.74 times. With this being over 2 times, it suggests that the company has little concerns over profitability and also highlights that a dividend was sustainable. Despite this impressive performance in 2019, a 2018 dividend cover of 1.23 times suggested that it was unsustainable to payout dividends. One such issue in the case of Next plc was that they have built up a reputation of paying annual dividends and in turn attracting both value and growth investors. In 2018, they would have been better off to refrain from paying dividends but this could have indicated a financial weakness to its shareholders, subsequently negatively impacting its share price.

Activity Next Plc has impressive financial muscle in regard to its liquidity, interest cover, profitability but one area which causes concerns is its ability to recover amounts due. A receivable day’s figure of 128 days represents a cost to the business since, as it is effectively giving free credit to its customers out of its own resources. This figure has increased since 2018, demonstrating increasing sales on credit but also the increased risk which it carries.

Similarly, Next Plc has increased inventory days from 64 days in 2018 to 70 days in 2019, having high inventory days has the potential to result in increased costs of extra warehousing and security costs. Next operates in the clothing industry, while clothes don’t go obsolete, they can go out of fashion, making it more illiquid and difficult to turn into cash. Therefore, keeping inventory for such a period of time may result in additional, unnecessary risks and costs.

Activity Ratios 2018 - 2019 2019 Receivable days 128 days Inventory days 70 days Payable days 30 days Operating Cash Cycle 197 days Cash Cycle 167 days

2018 107 days 64 days 23 days 171 days 148 days

Next Plc is not taking full advantage of available trade credit as it pays its creditors on average in 30 days in 2019 and 27 days in 2018. As this figure is attractive for its suppliers, 10

Next may be offered discounts and competitive prices which in turn contributes to its high profitability, but at the cost of a positive cash cycle of 167 days has a negative impact for Next Plc as operations must be funded for 167 days as creditors are paid before money is received from debtors and stock is sold. This, in turn, may result in bank overdraft interest, additional administration costs for cash collection and also lost investment opportunities. Despite this, the company remains liquid and highly profitable in comparison to its closest competitors.

Liquidity In order to avoid insolvency, it is vital for a company to obtain current assets greater than the value of their current liabilities in order to have financial freedom, this is referred to as liquidity. In the case of Next Plc, they have an impressive current ratio which is over the recommended ratio of 1:1, being 1.83:1. This compares very favorable in comparison to its competitors M&S and ASOS as displayed in the table below. Similarly, Next has an appetizing quick ratio of 1.37:1 which translates to having €1.37 of liquid assets for every €1 worth ...