UNIVERSITY OF BRADFORD

School:

Management

Module Tutor/Supervisor:

Dr. Aydin Ozkan

Module Number:

MAN4214M

Module Name:

Corporate Finance

Title of Essay Question:

Please provide the whole question:

Equity valuation of Next Plc through P/E and

Discount cash flow techniques and compare with
competitors.

UB Number:

14021365

Date of Submission:

27 Apr 2015

Mode of Study (on site/distance Learner)

On site

Word count (not including bibliography

and appendices):

2058

Statement of Authenticity:
By submitting this assignment through Blackboard, I confirm:
That this work is my own and that I have not plagiarised the work of others in any form whatsoever.
That I am aware of the Universitys definition of Plagiarism and understand how it can be avoided.
That this work, or any part of it, has not been previously submitted to the University of Bradford for
assessment in any other module.
That I have read and understood the information provided below.

Signed:

Gurkeerat Singh Kalra

Date: 27 Apr 2015_

Introduction
Next plc based in UK is a well known retailer for clothing and other casual accessories
(Reuters 2015). As shown in Figure 1 business landscape, Next operates with its 3
mail distribution channels i.e. Next Retail (with around 500 stores), Next sourcing and
Lispy in UK, Next Directory (Online channel with product catalogue and integrated
delivery in 60 countries) and Next international with 200 franchises across world (HL,
2014).

Figure 1: Business Landscape - Next Plc

(Source: HL, 2014)

Next was listed first on London stock exchange on March 12, 1948 and today it is
listed on FTSE 100 Index as well (LSE, Next 2014). This assignment is focused on
current company valuation of equity for Next Plc in UK and evaluating the value Next
Plc has delivered to its shareholders since last five years. The 2 valuation techniques
employed are Price/Earnings Ratio (P/E) analysis and Discounted Cash Flows (DCD).
Where possible a reasonable justification over the difference in derived value from the
valuation techniques is provided taking into account the facts and assumptions
concerned.
Value analysis of shareholder has been carried out using Total Shareholder Return
(TSR) technique with focus on dividend and capital gain. The valuation figures are also
compared with competitors of same industry sector i.e. M&S and Debenhams and
almost same size, to evaluate future growth and market perception. Companys
annual reports are utilized as a source of key figures from financial statements from
various online database resources provided by university.
Closest Competitors
As stated by Bloomberg Business (2012), it has grabbed the title Britains Largest
Clothing Retailer from M & S Groups plc. Since the closest competitors are compared

in terms of Industry sector (i.e. consumer goods retail), Gross Revenue or turnover
and total assets, please refer to Appendix 1 for detailed comparison.
As an Investor, Next holds a more attractive position than rival companies as it has
well positioned its online sales with the shift of buying trend from retail store sales to
online channel.
As per a report in 2013, Next Directory Online and catalogue (mentioned in figure1)
account to 35% of group sales and is growing at a good pace while M&Ss online
offering accounted 6.5% of group sales, giving Next greater sales revenue and thus
greater profit margin (Hargreaves, 2013).
Also, since 35% (one third) of group sales are online, there is a significant saving in
store running and staffing cost.

Table 1: Financial data of Next plc

(Source: FT, 2014)

Table 1 mentions the financial highlights of Next Plc over the past 5 years and it is
evident that there is steady increase in sales but since Asset turnover reached its
lowest in 2014 due to larger portion of receivables included in current assets of Nexts
balance sheet.
Valuation
Valuation of a company is a method of calculating the current worth of its assets,
market shares and future expected cash flows and it is required by directors to
understand the impact of financial decisions like acquisitions and mergers, investment
analysis and capital budgeting (Pike and Neale 2009). Valuation is also important to
measure company performance as it includes long term interest of company
stakeholders (i.e. management and employees) and shareholders (Koller et al. 2010).
According to Brealey and Myers (2000), the company valuation are used for a variety
of purposes such as, for the buying and selling operations of the company; to
compare the obtained value from the shares on the stock market; to choose the

securities that are to be concentrated by the portfolio; to make comparative studies

between the companies; to justify public offerings; to compare with the wills and
inheritances (other assets); for quantifying compensation schemes; for stratifying and
identifying main value drivers; for making strategic decisions for the existence of the
company and for measuring the impacts of strategies and policies of company up on
the creation and destruction of value.
Price- Earnings Ratio Analysis:
According to Paulasset (2012), the Price Earnings ratio or the PE ratio is one of the
common and most important stock valuation ratios. It can be defined as the ratio of
the current market share price of the company to its annual earnings per share.
Formula

P / E = Market Value per Share / Earnings per Share (EPS)

The PE ratio is considered significant as it points out how expensive or how cheaper a
stock is (Research Desk, 2007). It is also claimed that, the PE ratio offers a good
opportunity for buying stocks at cheaper price. The companies, which doesnt make
profit or incur loss have a negative or zero PE ratio. Thus, the PE ratio is considered as
a simple and good measure of stock valuation, supporting novice investors.
(Note: Please refer to detailed calculations and assumptions of P E Ratio in the Appendix 2)

Table 2: P E Ratio of Next plc, Marks & Spencer Group plc and Debenhams
(Source: Annual Report Next, M &S, Debenhams, Fame, 2015)

The table above (table 2) presents the Price- Earnings ratio of Next plc, Marks &
Spencer Group plc and
Debenhams from 2010 to
2014.
As of the year 2010, even
though there has been a
steady growth in all the 3
companies over the next

consecutive years, Marks & Spencer Group plc has been the market leader with a
maximum PE ratio of 11.27.
Figure 2: Price- Earnings ratio of Next Plc, Marks & Spencer Group
plc and Debenhams

( Source: Annual Report Next, M&S,

Debenhams)

The year 2011 (Figure 2) can be explained as slowdown or crisis recovery year for all
three companies where market price per share had a slow increase for Next and M&S.
While for Debenhams, the price fall substantially i.e. 14.1 %. During the third quarter
of year 2012, Next opened new outlets in UK high street and revenue boosted to 0.2
%. April and June 2012 had high rainfall and thus Nexts online Directory (Figure 1)
witnessed a total jump in sales of 4.5% in 2012 (Trotman, 2012).

Table 3: NOPAT calculation for P/E value analysis

(Source: Annual Report Next)

The above table demonstrates the calculation of PER value for Next Plc and its
comparison with Market Cap to measure accuracy (provided the assumptions and
value comparison in Appendix 2). Year 2014 has been the best for Operating profit a
value of 9.97 Billion .

Discounted Cash Flow (DCF):

According to Harrison and David (2003), the technique of determining the status of
business in future depending up on its current state is called as the Discounted Cash
Flow (DCF) analysis. Mostly, the Discounted Cash Flow analysis is used routinely by

people who are in a plan of buying a business (Inc 2015). Cash flow forms the basis of
the business. According to Investing Answers (2001), one biggest advantage of
Discounted Cash Flow is considered to be that it considers the fact of investing the
money in business soon as we receive it. Presented below are the Discounted Cash
Flow of the Next plc and its 2 competitors, the Marks & Spencer Group plc and the
Debenhams.
Formula

Following table shows the calculation for Present value of free cash flows from 2015 to
2019.

Table 4 (a): Discounted cash flow of Next plc

(Source: Self, table 4(b))
Note: Please refer appendix 3 for detailed DCF assumptions.

Discount Rate (Cost of Capital or Ke) is calculated in Table 4 (b)

Terminal value
TV = Free cash flow (2020) / (Wacc - Rate of growth) = 843525/ (4.28 2.4) =
448683.5 thousand GBP
NPV = 348926 thousand GBP
i.e. Value of Equity = 3693155 +348926 = 4042081 thousand GBP = 4.042 Billion
GBP

Cost of Equity
Net present value asserts on value of wealth to a particular forecasted time using the
discount rate. Following table employs CAPM model to calculate cost of equity (Pike
and Neale 2009).
CAPM Equation
Ke = Rf + (Beta *Rm)

where,
Ke = Cost of Equity
Rf = Risk free rate
Beta = Risk Rate
Rm = Equity Risk
(b): Cost of Equity or
Factor

CAPM
R(f) - Risk Free
Rate
Beta

%
0.22

Source
US Treasury 2015

0.64

R(M) - Risk
Premium
Discount Factor
(WACC)

6.35

Thomson Reuters
2015
Aswath Damodoran
2015

Premium
Table 4
discount

4.28

(Source:

Mentioned in table, CAPM equation)

As seen above CAPM model relies on market risk to derive discount factor. This
method is globally conventional to derive cost of Equity.
Valuation Result
Following is the resultant value of P/E and DCF models for Next Plc. As evident the P/E
and Market value are close enough. DCF calculation result is higher than P/E as this
valuation method employs future cash flows and thus potential future growth of the
company.
Market
Value
9.48b

P /E
Multiple
Value
9.97b

DCF
Valuations
4.04b

Table 4 (c): Valuation Summary

(Source: table 3, 4(a) summary)

Shareholder Value Analysis

There are various approaches to determine how the company is performing during the
last five years and eventually adding value to its shareholders. We will go through TSR
(Total shareholder return) in this paper. The total shareholder return (TSR) figure to an
investor is the measure of performance a companys share and stock.

It is a summation of dividends payable (as per companys dividend distribution policy)

and share price appreciation (capital gain). Since the calculation involves share price
when dividends are paid, an approximation of price average from start to end of the
year has to be incorporated thus the TSR figure is not quite accurate or exact.

Formula

Figure 3: NEXT plc Performance Chart 2009-2014 Total Shareholder

Return
(Source: NEXT Plc)

The graph above (Figure 3) shows the companys performance in last 5 years
compared with FTSE All share and FTSE General Retailers index to compare
companys TSR with a wide UK index and a sector specific index. Since the return
dropped negative in 2008-09 as compared to 2009-10, the starting scale of year 2009
in figure 3 is taken as 100.

Table 5: NEXT plc Total Shareholder Return calculation

(Source: NEXT Plc Annual Report 2009-14, Share price calculator 2014)

Next Plcs share price calculator and dividend history from financial statements were
used as a source of Table 5. For a more consequential demonstration, the expected
return can be compared with the risk of investment. Next Plcs TSR has been
unstable since last 5 years. Since the dividend per share has been almost
incremental from 15 to 23%, share price change or capital gain has been the main
driver of TSR in past 5 years. As part of Nexts strategy for delivering sustainable long
term growth in EPS, it has been returning capital to shareholders through share
buybacks (in addition to dividends) which are accounted through both on-market and
off-market share purchases (Next Corporate, 2015). As per Next, TSR is the growth in
EPS added to dividend yield received. What the share price does in market is outside
company's control, but Next believes that eventually share price is likely to reveal the
growth in EPS (HL 2015). This is shown below in figure 4.
Figure 4 shows the share price movement of Next UK plc over the past 16 years and
conveys how share price follows EPS historically. The high rating in 2014 imply that
use of surplus cash, as special dividend or share buyback, gives less returns to
shareholders than expected if rating was low or risk (Investigate 2015).

Figure 4: Share price movement of Next UK plc

(Source: Investigate 2015)

Shareholders particularly invest for either capital gain or earnings from dividend
payouts. Next Plc has made profit (5 years) and rewarded a constantly increasing
dividend and so is the share price increase each year. This has attributed to a positive
TSR and displays deprived value for investors. The year 2010-11 can be explained as
a fall in market price.

Conclusion:
To conclude that if the results are overvalued or undervalued, a market benchmark is
needed.
Although under or overvaluation makes a market inefficient, it is sometimes beneficial
for the investor as it associates risk and return. Stocks with low declining PE ratio are
believed to give higher risk adjusted return than those with high PE ratio (Bondt &
Thaler, 1985). The higher the PE ratio of Next plc points out that they are growth
stocks and investors expect better return in the next few years. Considering the
market rate of return Next is valued 10.968 b, which is close to PE but since DCF
employs future values, it is undervalued (almost 50%) with 4.04 b.
Although, the shareholders are already getting good returns, undervaluation might
even attract more investors to buy and since Next is sustaining its results in capital
gain, dividend payout (returns), this situation calls investors for long term. Next has
always been performing share buybacks and dividend correction, for adjusting the
returns and increasing shareholders trust and might not be an issue to do again.

Appendix
Appendix 1 - Competitor Comparison
Next Plc
Financial
data
(
millions)
Revenue
Gross
profit
Net
income
Total
assets
Asset
turnover
Ratio
M&S
Group Plc
Financial
data
(
millions)
Revenue
Gross
profit
Net
income
Total
assets

2010

2011

3406.
5

3453.
7
1008.
7

996.9

2012

2013

2014

3441.1

3562.8

3740

1045.3

1125.8

1240.
1

364.1

401.1

474.9

508.6

553.2

1693.
5

1736.
6

1819.1

1828

2074.
3

3.64

3.82

3.20

3.52

3.02

2010

2011

2012

2013

2014

9537

9740

9934

10027

10310

3619

3725

3755

3797

3871

523

599

490

458

506

7153

7162

7182

7362

7704

Asset
turnover
Ratio
Debenham
s
Financial
data
(
millions)
Revenue
Gross
profit
Net
income
Total
assets
Asset
turnover
Ratio

1.81

1.97

1.92

1.96

1.93

2010

2011

2012

2013

2014

2119.
9

2209.
8

2229.8

2282.2

2312.
7

281

296.7

302.3

310.1

279.3

97

117.2

125.3

127.9

87.2

2087.
3

2014.
3

2091.2

2128.2

2141.
5

2.11

1.70

1.63

1.65

1.67

(Source: Fame, 2015)

Assumptions
1. Operating profit is without deductions including dilution due to discontinued operations.
2. No exceptional items deducted from profit after tax.
3. The affect of M&S year ending march every year is ignored (i.e. 2 months later than Next Plc)

Appendix 2 - Price Earnings Ratio Analysis

Next Plc
Year

Market
value per
share ()

Earnings
( Million)
(Profit
after tax)

Ordinary
shares
(Millions)

Earnings per
share ()

PE ratio

2010
2011
2012
2013
2014

19.66
19.94
26.39
40.59
62.9

364
400.9
474.8
508.6
553.2

1.93
1.81
1.86
1.71
1.51

188.6
221.5
255.3
297.4
366.4

10.42
9.00
10.34
13.65
17.17

Market
value per
share ()

Earnings
( Million)
(Profit
after tax)

Ordinary
shares
(Millions)

Earnings per
share ()

PE ratio

M&S
Year

2010
2011
2012
2013
2014

377.55
377.91
352.95
346.11
457.93

523
598.6
489.6
444.8
506

15.61
15.43
15.06
15.72
15.57

33.5
38.8
32.5
28.3
32.5

11.27
9.74
10.86
12.23
14.09

Year

Market
value per
share ()

Earnings
( Million)
(Profit
after tax)

Ordinary
shares
(Millions)

Earnings per
share ()

PE ratio

2010
2011
2012
2013
2014

58.7
51.42
96.53
106.7
66

97
117.2
125.3
115.9
87.2

12.93
13.63
12.79
12.60
12.28

7.5
8.6
9.8
9.2
7.1

7.83
5.98
9.85
11.60
9.30

Debenhams

(Source: Financial statements Next Plc, M&S, Debenhams)

M&S || Debenhams valuation 2014

2014
Company

Next
M&S
Debenha
ms

P/E

17.1
7
14.0
9
9.36

NOPA
T

Value

580.8

9972.33
6

489

6890.01

87.2

816.192

Source: Fame, 2015

Assumptions
1. Operating profit is without deductions including dilution due to discontinued operations.
3. The affect of M&S year ending march every year is ignored (i.e. 2 months later than Next Plc)

Appendix 3 Discounted Cash Flow (DCF)

Assumptions

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