Broker tips: Next, Morrisons

Numis reiterated an ‘add’ rating and target price of 5,750p for Next after the retailer reported its first quarter trading update.

Next reported total sales in the three months to 2 May fell 0.2% from a year earlier, while full price sales were 0.9% lower, reflecting colder weather in March and April which hit demand for clothing.

The company also warned that sales and profits could be lower than previously guided due to a potential slowdown in consumer spending.

It now expects full-price sales for 2016 to range between a 3.5% fall and a 3.5% rise, a wider range than its previous forecast range of between a 1% fall and a 4% rise.

"We believe it is unlikely (but possible) that sales will deteriorate further, and we have seen a significant improvement over the last few days as temperatures have risen," the company said.

"However, the poor performance of the last six weeks may be indicative of weaker underlying demand for clothing and a potentially wider slowdown in consumer spending."

The firm also widened and lowered the range of its full-year profit estimates to between £748m and £852m, compared with the previous forecast issued in March of between £784m and £858m.

However, Numis said the shares look “good value” following a 35% fall since December 2015.

The shares trade on a 17% 2016 calendar year price to earnings ratio discount to the sector and nearly 30% below the £69.62 ceiling for the share buyback, with scope to extend it if there is significant demand for its upcoming bond issue.

“It is difficult to discern between the effect of unseasonal weather and the weakening general consumer backdrop over short periods,” according to Numis analysts Matthew Taylor and Andrew Wade.

“However, Next has tuned its own business and profit guidance to a tougher environment, while the same may not be said for many of its peers. In this context we view the 17% PE discount to the sector as good value, even if only on a relative basis.”

Bernstein downgraded Morrisons to ‘underperform’ from ‘market perform’ and cut the price target to 160p from 170p, saying the valuation has run ahead of itself and structural problems remain.

“The City has been excited by Morrisons' positive Q4 2015 LFL sales growth and the deal with Amazon was a welcome surprise for shareholders. A rally in the share price followed making it the best performer of our coverage since December,” said Bernstein.

However, the bank reckons enthusiasm and valuation have run ahead of themselves, pointing out that structural problems such as a lack of differentiation and limited growth options are still there.

In terms of the weak differentiation, Bernstein noted that when it comes to private label food, Aldi and Lidl are materially cheaper, while Asda is 4% cheaper on branded and Tesco’s Farm Brands focus on value-oriented fresh food, which is the heart of Morrisons' current strength.

On growth, the bank highlighted that Morrisons’ offer is in the supermarket segment, the slowest growing part of food retail, with almost no exposure to convenience retail, which is the fastest growing UK segment, and limited online.

“Relative growth is biggest driver of food retail margins, and Morrisons has the weakest channel-mix of all three quoted retailers.”

Bernstein said that even if it gives full credit to management's recent guidance of £50-£100m of incremental pre-tax profit in the medium term, and assumes an amazing Amazon-supply business, it is still 7% below EBIT for this year and 10% below EPS.

The bank said that even if it accepts consensus EPS and EPS growth expectations, the stock still trades 20% above its fair value.

“We are one day before Morrisons' Q1 sales results, and those may get people excited. But our downgrade rests on the longer term earnings and cash generating capabilities of the business.”