Broker tips: Next, CVC Group

Analysts at Credit Suisse sounded a very cautious note on Next's trading over the medium-term, flagging to clients the rapid decline seen in the retailer's core profitability even as the outlook for its non-core units worsened.

Even with a £49m increase in profits before tax at its Credit, Label and International segments, the company still reported a full-year drop in earnings of £31m, as the core Next UK Brand saw a 12% fall as margins were eroded by 180 basis points.

Yet even that positive contribution would decline to £11m this year and was expected to negative in 2018, as credit income "rolled over", analysts Simon Irwin and Pradeep Pratti said in a research note sent to clients.

Account growth at credit was at multi-year lows and Core Directory margins (ex Credit, Label, International) had been declining for six years.

"And we see little change in the proposition which would alter that," they said.

"It is becoming increasingly hard to defend high market shares in a fragmenting apparel market, and we regard the decision to increase prices in a deflationary market as risk."

So while the broker increased its estimates for the company's earnings per share in future years by 2% it did not expect the bottom line to recover in later years, with further reductions in margins and cash conversion "inevitable".

Despite that, the change in the broker's numbers worked out to an improved target price of 4,250p, up from 4,100p previously. The recommendation on the shares was kept at 'Neutral'.

CVS Group

Analysts at Berenberg hailed CVS Group's shift in its business mix, with the resulting margin expansion that resulted, reiterating their 'Buy' recommendation on the stock in the process.

However, like-for-like sales were likely to slow towards the sector average in second half of the year, the broker cautioned.

Even so, the broker raised its earnings per share forecasts for 2017 to 2019 by 4% for each year, as a result of which it bumped up its target from 1,200p to 1,220p.

Although investors often focus on the rate of growth in like-for-like sales and M&A when analysing the veterinary group, the most noteworthy aspect of the firm's interims was its improved operating margin at the operating level, it said.

In terms of earnings before interest, taxes, depreciation and amortisation, margins rose to 16.1% from 14.5% in the previous six-month stretch, even as CVS invested significantly on people and equipment.

The key to the fatter margins was nevertheless the "strong improvement" in profitability in the vet practice side of the business, as CVS shifted towards higher-margin services versus drugs even as it moved to use more of its own brand drugs, with the latter having their own benefits.

"We have increased our forecast margins for the business as we believe the business will continue to benefit as the volume of own brand drugs sold in the business continues to grow," Berenberg said.

Analyst Sam England also pointed out that the company's M&A continued to be highly accretive even though in the latest six months it had paid an average price of 7.5 times historical EBITDA, instead of the seven times operating profits seen in fiscal year 2016.

That contributed to England's decision to lift his estimates.

CVS still had between £30m to £40m of firepower for M&A left, assuming it leveraged up the business to 2.5 times profits, he said.

On a slightly more cautious note, England tipped his hat to the company's "exceptionally strong" 7.2% increase in LFL in the first half of 2017 but added that a level of growth closer to the UK veterinary market's average rate of between 3% to 4% was more likely in the second half.