Is FTSE 100 Stalwart Next Good Value?

Published in Company Comment on 14 December 2012

Can Next's (LSE: NXT) growth continue and are the shares cheap?

Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:

  • growth in earnings, and
  • an upwards P/E re-rating.

Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.

Seeking durable growth

Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the last five years:

Year to June200720082009201020112012
FTSE 100 index660856264249491759465571
Aggregate earnings per share537503427397527557

Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.

One contender is Next (LSE: NXT), which is a UK-based retailer of fashion and accessories. This table summarises the company's recent financial record:

Year to January20082009201020112012
Revenue (£m)33293272340732983441
Adjusted earnings per share168.7p156p188.5p217.6p253.9p

So, earnings have grown at an equivalent 10.8% compound annual growth rate, putting Next in the Stalwart category.

Next last updated the market on the 31 October saying that full-year earnings are expected to come in up between 10 and 15%. That sounds like 'steady as she goes', to me, with performance along the lines of what we've come to expect.

The Next brand was established in 1982 and has expanded steadily ever since. Now, the firm gets its range of clothing, flowers, gifts, sports gear, baby gear and electricals out into the market via its chain of more than 500 stores in UK and Ireland, 200 mainly franchised stores around the world, and its home shopping catalogues and websites that serve around 50 countries.

Last year, around 64% of sales were through its Retail division, 32% through its catalogue and internet Directory division, just over 2% from its fledgling International internet division and the rest from other sources. Growth continues apace and the company has a good record on converting sales to cash flow. That cash backs earnings, and there's no sign of forward weakness on that score.

Next's earnings growth and value score

I analyse five indicators to determine whether earnings growth can continue and if the shares offer good value:

1. Growth: steady earnings and cash flow growth but revenue up and down. 4/5

2. Level of debt: net debt is around last year's earnings. 4/5

3. Outlook and current trading: good recent trading and a cautiously positive outlook. 4/5

4. Enterprise value to free cash flow: trailing around 20, just above historic growth. 3/5

5. Price to earnings: trailing at about 14.75, just above historic growth rates. 3/5

Overall, I score Next 18 out of 25, which encourages me to believe this stalwart can continue earnings growth that outpaces that of the wider FTSE 100, and that the shares offer reasonable value when compared to the FTSE's price-to-earnings (P/E) ratio of around 11 and the firm's growth predictions.

Foolish summary

Cash flow is strong and backs up earnings. Borrowings seem under control and the outlook is encouraging.

Right now, forecast earning growth is 10% for the year to January 2014, and the forward P/E ratio is just over 12 with the shares at 3,746p. Considering that and the other factors analysed in this article, I think that looks quite attractive.

Next is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.

If you, like me, are serious about capital gains, I recommend you now read "The One UK Share Warren Buffett Loves", which is a time-limited Motley Fool free report discussing the British Stalwart that has recently attracted some of the American super-investor's billions.

This one UK share ticked the boxes for Warren Buffett on growth prospects and cheapness, maybe it will for you too. Click here to access the report while you still can.

> Kevin does not own any shares mentioned in this article.

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