Shares of high street fashion retailer Next (LSE: NXT) climbed 7% this morning, after the group reported better-than-expected Christmas sales. Full price sales rose by 1.5% over the 54 days to 24 December, well ahead of management’s previous guidance for a 0.3% drop over the same period.
A 13.6% increase in online sales helped to bail out the group’s flagging retail stores, where sales fell by 6.1% compared to the same pre-Christmas period in 2016.
Next has now upgraded its central pre-tax profit guidance for the year ending 28 January by £8m to £725m. That’s good news for shareholders like me. But the group’s outlook for the year ahead is less certain. Is it time for turnaround investors to consider taking profits?
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Looking ahead
Next’s shares have been volatile over the last year as the group’s fortunes have been influenced by uncertain consumer spending and unseasonal weather. Although it’s early to be issuing guidance for the year ahead, chief executive Lord Wolfson says that he expects “operational costs to continue to grow faster than sales”.
The firm’s central guidance is for pre-tax profit to fall about 3% to £705m. Free cash flow after the ordinary dividend is currently expected to be broadly unchanged at around £300m. The group plans to return this cash to shareholders through buybacks, which should help to support earnings per share.
I believe Next remains a good quality business, with high profit margins, strong management and good cash generation. The shares trade on 11 times earnings and free cash flow and offer an ordinary dividend of 3.5%.
This could be a good value investment. My only concern is that profits could remain flat for several years. I plan to continue holding, but I’d wait for the next dip to buy more.
A better alternative?
Another company whose management has a strong and successful focus on cash generation is insurance group Aviva (LSE: AV). This stock has been an income holding in my portfolio for a number of years, during which time I’ve steadily bought more shares.
I topped up my holding in November and remain attracted to this company’s income potential. The stock offers a well-covered forecast yield of 5.3% for 2017, and is expected to increase its payout by 9% to 29p in 2018, implying a yield of almost 5.8%.
Growth opportunity?
Aviva’s latest management update suggests to me that chief executive Mark Wilson believes the business has completed its turnaround, and is now positioned for fresh growth.
Mr Wilson expects the group to generate £8bn of cash between 2016 and 2018. £3bn of this is expected to be used in 2018 and 2019 to fund £900m of debt reduction, small acquisitions and shareholder returns.
The firm’s guidance is for earnings per share to rise by more than 5% per year from 2019. The dividend payout ratio will be increased to 55-60% of earnings by 2020, thanks to “improved earnings quality and cash flow”.
In my view, Mr Wilson has delivered excellent results for shareholders during his time in charge. Despite this, the stock remains affordable, on a 2018 forecast P/E of just 9 with a prospective yield of 5.8%. I believe these shares remain a solid income buy.
