Introduction
Next Plc is an organization known for providing fashion retail services and clothing accessories in the UK and it is listed in LSE. The company is usually involved in retailing fashion products clothing home accessories and consumer services management. Next PLC has around 500 stores which are operating in the United Kingdom while its partners of franchise operate around 199 stores in more than 35 Nations. The company also offers online products and services to its consumers by facilitating upgraded accounts and other online activities on its websites. The company has a revenue of £4.63 billion and a market cap. of £7.75 billion and currently, its net income is £677.50 million. Around 27000 employees are working on Next Plc and serving the consumers of the fashion retail organization. Next plc has some major competitors in the UK market and these are M&S, Asos Plc, Matalan.co.uk, Debenhams Plc, etc (Yan et al. 2022).
In this report, the risk profit of Next Plc is going to be analyzed by comparing its performance with its competitors. The significant part of the risk and capital structure of the business organization is evaluated for understanding the overall framework of the company and the pay-out policy of the business organization helps to understand the perspective of investing in the company towards a beneficial perception. In the end, the conclusion part demonstrates the detailed information and major key aspects of the entire report in brief.
Part 1: Risk profile
There are usually two types of risk which are systematic risk and unsystematic risk. Systematic risk is associated with those risks that can impact the whole market because of any financial, political, or economic condition. Unsystematic risks are those that are associated with the company’s internal and specific risks such as location risks, management risks, and succession risks.
Below following steps have been taken to evaluate the risk profile of Next Plc and its competitors:
First step: We have gathered 5 years of adjusted monthly closing prices of three companies along the FTSE All-Share by using Yahoo Finance as the source from July 2016 to June 2021. Afterward, the returns of all three companies have been calculated along with the return of FTSE All shares by using the below-given formula:
Return = Price at time t / Price at time (t-1) – 1
Second step: After calculating the return of the three companies, a regression analysis has been made to determine the Beta, intercept, and associated risk with the share price of these companies along with the FTSE All-share. The beta for Next Plc has been calculated as 1.39 and as per beta, Next Plc has a higher risk as its beta is higher than 1.2.
The equation used is: Ri = a + bRm
The outputs generated through regression are:
| SUMMARY OUTPUT | ||||||||
| Regression Statistics | ||||||||
| Multiple R | 0.563866616 | 1-R square | ||||||
| R Square | 0.31794556 | 0.68205444 | ||||||
| Adjusted R Square | 0.305979693 | |||||||
| Standard Error | 0.082729541 | |||||||
| Observations | 59 | |||||||
| ANOVA | ||||||||
| df | SS | MS | F | Significance F | ||||
| Regression | 1 | 0.181856911 | 0.181856911 | 26.57104167 | 3.31257E-06 | |||
| Residual | 57 | 0.390118086 | 0.006844177 | |||||
| Total | 58 | 0.571974996 | ||||||
| Coefficients | Standard Error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
| Intercept | 0.010031279 | 0.010790211 | 0.929664718 | 0.356465269 | -0.011575747 | 0.031638304 | -0.011575747 | 0.031638304 |
| X Variable 1 | 1.399462622 | 0.271491985 | 5.15471063 | 3.31257E-06 | 0.855809299 | 1.943115944 | 0.855809299 | 1.943115944 |
Next Plc (NXT.L)_FTSE 100:
Returns of NXT.L = 0.01 + 1.39 Returns of FTSE All Share
Asos Plc (ASOS)_FTSE 250:
Returns of ASOS = 0.34 + 3.28 Returns of FTSE All Share
Devro Plc (DVO)_FTSE 250 (Small Cap):
Returns of DVO = -0.00 + 0.87 Returns of FTSE All Share
| Companies | R squared | 1-R squared |
| Next Plc | 31% | 69% |
| Asos Plc | 2% | 98% |
| Devro Plc | 11% | 89% |
Table 1.1: Determining the R square and 1-R square
(Source: MS Excel)
Third step: In this step, the calculation of annualized and monthly Jensen’s Alpha for each company is made by using the below equation:
Jensen’s Alpha = a – Rf (1-b)
The 5-year bond yield of the UK Government is considered here as the rate of risk-free which is 1.35%(Bloomberg. com) every year and after converting it for each month, the rate is valued as:
1.35%/12 = 0.001125
| Intercept (a) | Monthly risk-free rate (rf) | Beta (b) | Monthly Jensen’s Alpha
a-rf(1-b) |
| 0.01 | 0.1125 | 1.399462622 | 5.50% |
| Company | Monthly Jensen’s Alpha | Annualised Jensen’s Alpha |
| Next Plc | 5.50% | 90.06% |
Table 1.2: computation of annualized and monthly Jensen’s Alpha for Next Plc
(Source: MS Excel)
Analysis of risk profile
As per the above calculation for Next plc, the beta for the firm is calculated as 1.39 it shows that if the beta of FTSE All share increases by 10%, the beta for Next Plc will also be moved by 13.99(1.39 x 10) and vice versa. This shows a linear positive relationship between Next Plc’s overall market and particular stock. Also, as per beta, next Plc has a higher risk as the value of its beta is more than 1.2. As per CAPM, the r-squared for Next plc is determined as 31% which shows that this 31% of risk comes from its market and the rest 1-r squared which was calculated as 69% is the firm’s specific risk. The lower risk of 31% from the market indicates the risk of change in exchange rates, prices of equity or commodity, and rates of interest are usually lower than the specific risk of the firm (Rahman 2019). The specific risk for Next Plc is higher because the nature of its products which are fashion accessories and products is very sensitive and the chances of increasing and decreasing its prices or other factors are higher. Therefore, for this factor, Next Plc has a higher specific risk than the market risk. As per Table 1.2, annualized Jensen’s alpha for Next Plc is determined as 90.06% which shows that Next Plc has performed higher than expected and a positive value is determined. Comparing it with its peers it has been analyzed that the performance of the fashion retail industry in FTSE All share in the last 5 years is very attractive which could be one possible reason that Next Plc has performed higher than expected.
For the year 2021, the total debt of Next Plc has been determined as 2442300 while the value of its shareholder’s equity for the same year is analyzed as 660900 (finance.yahoo.com). By dividing the debt value by the value company’s shareholders’ equity, a ratio of debt-equity is calculated which is 3.69%. This shows that the company has had higher leverage in the most recent years as its debt value is higher than the value of its equity. Therefore, this higher financial leverage is one of the possible reasons why Next Plc’s specific risk is higher. The market risks that impact the performance of Next Plc are increasing or decreasing prices of its commodity or any changes in the rate of interest and foreign exchange.
Recommendations
As per the above analysis, it has been determined that Next Plc has 69% of specific risk due to market risks. Therefore, Next Plc is recommended to lower the percentage of its specific risk by maintaining stability in the prices of its commodity and equity in the market. This could be one possible alternative through which the form can reduce the percentage of its specific risk in the market and gain higher profits (Flynn and Walker 2020). Next Plc is also recommended to adopt useful strategies of risk mitigation which could be one possible method through which the risk underlies in the business activities of the form can be decreased. Next plc is recommended to reduce the value of its higher debt along with operational leverage because of which the financial performance of this firm could be improved.
Part 2: Capital structure
The total date of the next plc for the year 2021 is determined as 2442300 and the value of its shareholder equity for the same year is 660900. This shows that the weight of debt in the long-term finance of Next plc is around 99.76% while the percentage of its equity is only 0.23%. WACC is usually the percentage of the cost of capital that is required for accompany. The inputs required to calculate these WACCs are the market value of the organization’s debt and equity, cost of equity and cost of debt, weight of both the debt and cost, and the rate of corporate tax.
Calculating the cost of equity
The cost of equity is usually the return that is expected to be received by investing in that equity or the price that investors want to pay. For the calculation of expected return or cost of equity the below formula is used:
Ra=Rrf+[Ba x (Rm-Rrf)] (efinancemanagement.com)
Expected return = rate of risk-free + Beta x (risk premium)
Therefore, the Beta of Next Plc from the above analysis = 1.39
Rate of risk-free(bloomerg.com) = 1.35%
Risk premium (statistica.com) = 5.9%
As of 2021, the risk premium for the UK is determined as 5.6% (statistic.com) and the calculation is below:
| Companies | Beta as of Part 1 | Rate of risk-free | Risk premium (2021) | Cost of equity (ke) |
| Next Plc | 1.39 | 1.35% | 5.9% | 9.55%ok |
Table 2.1: Computation of cost of equity of Next Plc
(Source: self-created)
Estimating the cost of debt
| Company | Interest expense (A) | Book value of debt (B) | Cost of debt (kd)
(A) / (B) |
| Next plc | £102800 | £2442300 | 4.21%ok |
Table 2.2: Computation of cost of debt of Next Plc
(Source: self-created)
Estimating the weight of debt and equity
| Company | Market value of equity (E) | Book value of debt (D) | Weight of equity (E) / (E + D) | Weight of debt (D) / (E + D) |
| Next Plc | £7,95,30,69,00,000 | £1,85,28,00,000 | 99.76% | 0.23% |
Table 2.3: Computation of weight of debt and equity of Next Plc
(Source: self-created)
Market capitalization (equity) of Next plc currently (finance.yahoo.com) = £7,95,30,69,00,000
Book value of debt (finance.yahoo.com) = £1,85,28,00,000
Now, the market capitalisation is also called the market value of equity and it is used for the calculation of the weight of debt and equity together with the book value of debt.
Estimating the 1 minus average tax rate
| Companies | Tax | Pre-tax profit | Tax rate |
| 1 | 2 | 1/2 | |
| Next Plc | £55700 (finance.yahoo.com) | £342400 (finance.yahoo.com) | 17.69% |
Table 2.4: Computation of 1 minus average tax rate of Next Plc
(Source: self-created)
For calculating the 1 minus average tax rate of Next Plc the tax provision of the firm for the year 2021 has been used which is £55700 and the profit of pre-tax which is £342400 is also used (Upadhyay, 2022). The calculation is made by dividing the average tax for the last 2 years of Next Plc by its pre-tax profit for the same year.
Estimating the WACC of Next plc
| Company | Weight of debt | Cost of equity | Weight of Equity | Cost of debt | (1 – tax rate) | Cost of capital |
| E / (E + D) | (ke) | D / (E+D) | (kd) | (1 – t) | E / (E + D) x Cost of equity + D / (E+D) x Cost of debt x (1-t) | |
| Next Plc | 0.23 | 9.55% | 99.76 | 4.21% | 17.69% | 4.43% |
Table 2.5: Computation of WACC of Next Plc
(Source: self-created)
Analysis of cost of capital
As per the above calculation, the WACC of Next plc has been determined as 4.43%, and as compared to the ROIC of the firm which is 18.42% (finance.yahoo.com) it is lower and acceptable. This shows that higher returns are generated by Next Plc than its company’s cost of raising the capital required for that investment. It is determined that Next Plc is generating higher returns and if it continues to earn excess returns in the future its total worth will possibly increase. As compared to the average industry, the WACC of Next plc is lower and in an acceptable range.
Part 3: Policy of pay-out
| Next plc | 2019 | 2020 | 2021 |
| Source of return to shareholders (eg: dividends? Share buyback? Bonus shares? Or a combination?) | Dividend | Dividend | Dividend |
| Annual Dividend per share (GBPP | 110p | 57.5p | 110p |
| EPS (GBP) | £2.49 | £2.66 | £2.24 |
| Pay-out ratio | 44.18% | 21.62% | 49.11% |
| Dividend yield | 3.02% | 2.49% | 1.36% |
Table 3.1: Computation of policy pay-out of Next Plc
(Source: finance.yahoo.com)
From the above table, it has been determined that Next Plc is giving cash back to its shareholders, and in the last 3 years, the company has paid dividends to shareholders. In the year 2019, the annual dividend for each share of Next Plc has been determined as £110 and
the annual dividend of the Next Plc for the year 2020 has been determined as £57.5 which again increased and became £110 for the next year that is 2021. The EPS of Next Plc for the years 2019, 2020, and 2021 is determined as £2.49, £2.66, and £2.24. Therefore, by dividing the annual dividend for each share of the Next Plc by its EPS the ratio of its be out is calculated as 44.8 in the year 2019. This ratio of the out for the years 2020 and 2021 is calculated as 21.62 and 49.11. Again, the dividend of the Next Plc for the years 2019, 2020, and 2021 is calculated as 3.02%, 2.49%, and 1.36% (Tremblay 2020). The managers of Next Plc are usually reluctant to make changes in the dividend payment throughout the year and they are not cutting any dividends even if they are earnings decrease. The firm has provided a smooth dividend to shareholders in the last few years except in the year 2020 because of a viral epidemic.
Next Plc is giving cash back to shareholders in the form of a dividend because it is sharing its profit with the shareholders for their support in gaining high returns for the company. Next Plc is a leading fashion retail company with high market capitalization; therefore, the company is not required to reinvest its profits to grow its business and it offers its profits to this year’s holders as a dividend (Rahman, 2019). In the last 3 years, the company has paid a dividend to its shareholders, and in the year 2020, a lower dividend of £57.5 was experienced by the shareholders of Next plc. The reason why Next Plc is paying dividends to its shoulders and not giving buyback is not require the need to invest its profit to grow its business. The dividend yield and pay-out dividend of Next Plc are in line with the industry dividend.
Pros of dividends as compared to other options
There are major advantages of paying dividends which are going to be talked about in this section. There are several pros of dividend payments, if the company pays a dividend regularly, it attracts investors to invest in that company through which the financial condition and capital of the company could be enhanced. Also, if a company is paying dividends, it shows the stable performance of that company which also pulls the investor to invest and increases the value of the company in the market in terms of capital (Flynn and Walker 2020). Investors who were invested in the stock dividend are not required to sell their shares to engage in the growth of the stock and they could receive the benefit without even selling the stocks. A mature organization sometimes is not required to use the gain fully in their development and research activities and therefore they reinvest such profit to increase higher and excess returns in some other business or activities.
Pros of dividends as compared to other options
Paying the cash back to the shareholders in dividend form can also have some disadvantages. In a situation where the company fails to pay dividends to its shareholders, the company may lose its old shareholders who used to get regular payments and returns from the company (Adesunloro et al. 2019). One another disadvantage of paying dividends can be a decrease in the value of retained earnings and if the company is paying higher dividends, its debt and other unexpected expenditures could be increased. Also, paying dividends to the shareholders may hold the manager of the company to invest cash for company growth as no higher cash amount will be available after paying dividends to the shareholders. As compared to the buy-back shares providing a dividend to the shareholders is still more beneficial for both the company along the shareholders. As buyback is required by those firms that are not financially stable and have no years of experience in the market those companies are required to use their earned profit to buy back their shares. As Next plc is financially stable and has a healthy market capitalization in the last few years, paying dividends to shareholders is beneficial for them as it is not required to buy back shares.
Conclusion
In this following report, the risk profile of Next Plc is analyzed and compared with two other competitors such as Asos Plc and Devro Plc. From the risk profile and analysis, it is determined that Next plc has a higher beta of 1.39 which indicates a higher desk in its stock. It is determined that 69% of the risk in the Next plc comes from forms specific activities such as the increase in prices of its commodities or any exchange rate full stop therefore the company is recommended to work on improving its commodities and equity prices to avoid such higher specific risk. Also, the cost of capital of Next plc is calculated in the following report which is lower than its ROIC and indicates that the firm is generating higher and excess returns as compared to the invested capital and its investment. The pay-out policy of Next plc states that it has paid a stable dividend in the last 3 years to its shareholders.
Reference list
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Website incorrect. This should also be in Harvard-style referencing.
(finance.yahoo.com 2022) Next Plc [online] Available at: https://finance.yahoo.com/quote/ASC.L?p=ASC.L&.tsrc=fin-srch, [Accessed on 11.06.2022]
(finance.yahoo.com 2022) Next Plc [online] Available at: https://finance.yahoo.com/quote/DVO.L/history?period1=1560384000&period2=162354240, [Accessed on 11.06.2022]
(finance.yahoo.com 2022) Next Plc [Online] Available at 0&interval=1mo&filter=history&frequency=1mo&includeAdjustedClose=true [Accessed on 11.06.2022]
(finance.yahoo.com 2022) Next Plc [Online] Available at: https://finance.yahoo.com/quote/NXT.L?p=NXT.L&.tsrc=fin-srch, [Accessed on 11.06.2022]
(uk.investing.com 2022) Next Plc [Online] Available at: https://uk.investing.com/rates-bonds/uk-5-year-bond-yield, [Accessed on 11.06.2022]
