LONDON (Reuters Breakingviews) - Next is taking fashion cues from bankers, which doesn’t mean just donning a Hermes tie. The British high-street clothing chain has subjected itself to a stress test, previously the preserve of the financial world. In the worst scenario, where the average branch’s sales dip 6 percent a year for a decade, the net profit margin of its store portfolio will halve. Openness about the problems facing retailers is welcome. But this voluntary exam glosses over big risks.
The company deserves credit for addressing a question on all of its competitors’ minds. Will a big store network be an asset or a liability as shoppers increasingly buy with the click of a mouse? Next, whose market capitalisation was 6.1 billion pounds ($7.6 billion) by mid-Thursday, paints an upbeat picture. The net profit margin almost holds its own from the current 20 percent if like-for-like sales dip 2 percent annually, the average slowdown of the past five years. In its most stressed scenario, store net profit margins still hit 10 percent.
But in the same way that the European bank stress tests have underplayed hot-button risks like deflation and sovereign bond defaults, Next glosses over potential pitfalls. The group led by Chief Executive Simon Wolfson reckons it can cull the size of its store portfolio by shuttering unprofitable shops as their leases expire, leaving only its most lucrative locations. What Next doesn’t say is how many stores it reckons will still be open by the end of its 10-year timeline. Nor does it show its working on rising costs from staff wages, or sourcing clothing in Asia amid a depreciating sterling. The company already reckons general wage inflation will cost it an additional 8 million pounds this year.
Those things could change the outcome a lot. Imagine Next’s store sales halve over a decade – only slightly more dramatic than its own worst-case scenario. All else being equal, if its net profit margin halves too, earnings would fall by three-quarters. Close stores and that falls even further. Meanwhile, stress tests don’t easily predict how fickle customers will react to rising prices or next season’s designs. In kicking off an important conversation, Next has shown just how much retailers are operating in the dark.