• H1 pre-tax profits fell 1.5% to GBP342m (US$453m)
  • Total group sales were up 2.6% to GBP1.96bn
  • The weak pound will lead to a rise of up to 5% in cost prices in 2017
The last time Next had to increase the prices of its products was in 2010 when cotton costs soared

The last time Next had to increase the prices of its products was in 2010 when cotton costs soared

British fashion retailer Next Plc has posted a fall in first-half profits and says the pound's weakness since the Brexit vote is likely to increase sourcing costs by up to 5% next year for the first time in six years.

The last time Next had to increase the prices of its products was in 2010 when cotton costs soared, and it estimated at the time that "price elasticity was around 1.1". If that still remains the case, a retail selling price increase of 5% would result in a fall in unit sales of -5.5% and a fall in like for like sales value of between -0.5% to -1.0%.

"In the scheme of things, we think that this drag on sales is manageable and less damaging than taking a significant hit to margin," the company says.

It also plans to increase the amount of short lead time product over the next season, in a bid to increase the amount of on-trend items. In autumn, Next anticipates this short lead time product will represent 10% of the total, and increase further to 15% in winter, up significantly from 4% in spring/summer 2016. 

Posting its half-year results today (15 September), the UK's second-biggest clothing retailer said pre-tax profits fell 1.5% to GBP342m (US$453m) for the six months to the end of July.

Total group sales were up 2.6% to GBP1.96bn, with Retail sales were up 0.1% to GBP1.084bn, and Directory catalogue and online sales rising 7.1% to GBP821.2m. But comparable sales slipped 0.7% and full-price sales were down 4%, the company said.

The retailer's first-half profit margin narrowed from 14.9% to 12.4% on increased markdowns.

"As expected, it has been a challenging year so far, with economic and cyclical factors working against us, and it looks set to remain that way until mid-October at the earliest," said Next chief executive Lord Wolfson.

"We remain clear about where we need to focus our energies and continue to work on the priorities we set out at the beginning of the year."

Among the challenges it will face from next spring is the impact of the weak pound, which the retailer calculates will lead to a rise of up to 5% in cost prices in 2017.

Around 64% of Next's purchases are dollar-denominated, with the balance priced in euros, pounds or other local currencies.

However, as the company points out, "even in those territories where goods are priced in dollars, the fall in the pound will not fully translate into higher sterling prices. This is because ultimately, the dollar is only an intermediate currency. The value of the pound against a weighted basket of local currencies in our supplier territories shows a smaller devaluation."

And of course it is not an exact science. In 2016 the retailer experienced a similar devaluation without any material impact on sterling cost prices thanks to bringing in new sources of supply (such as Myanmar and Cambodia), broadening capabilities in low-cost sourcing countries such as Bangladesh, and increased competition and improving efficiency in mature territories like China and India. It also benefited from lower commodity prices.

The retailer adds: "This calculation is not straightforward because, in a world where fashion is changing so quickly, there will be very few garments which are directly comparable to those we are selling this year."

Next also has an internal sourcing agent, Next Sourcing, which procures around 40% of Next branded product.

The unit's sales were down 10% in local currency to US$419.7m during the first-half, "mainly as a result of competition from other third-party suppliers, in particular those who operate closer to home and have a better ability to respond faster to new trends."

Looking forward, Next Sourcing will focus on improving its product development capabilities and operations in Turkey, which, is its best-placed territory to respond to emerging trends.  For the full year it is expected to make around US$65m profit, a decline of 15% in local currency. Profit in sterling is likely to be slightly lower than last year's GBP50m.

Lord Wolfson also revealed the recent hot weather had hit sales of winter ranges this month – but that the retailer is for now maintaining its full year sales and profit forecasts. 

However, Bernstein analyst Jamie Merriman notes: "We worry that true inflation could be higher (given other rising costs like wages and commodities) and overall performance of the market under pressure.  Competitors are already signalling their plans to hold prices (e.g. Primark) and we see downside risk to expectations."