NEXT PLC's National Living Wage Strategy
How is one of UK's Stalwarts Mitigating Minimum Wage Increases
Please See Disclaimer at the bottom - This Report is not Investment Advice.
Introduction
I have always been optimistic about UK listed equities, despite the underperformance of many companies relative to peers in USA and Europe in the last 5 years. Ever since launching the Substack, I have pitched 3 UK listed companies that I believe have strong fundamentals and are trading at attractive valuations. Another business I am bullish about is NEXT PLC, a stock that has done well since COVID-19. This is article is not a pitch for the business as there are already many writeups on this incredible business which can be found online (I’ll attach the best writeup in the sources section). NEXT’s most recent trading statement gives a very interesting insight into how wage increases will affect large UK businesses and how they can minimise the impact of the cost component.
Background
On the 29th of October, the new UK Government announced NLW increases effective from April 2025. Minimum wages for 21-year-olds and over increased from £11.44 to £12.21, representing a 6.7% increase. For younger workers, rate increases varied depending on age group. 18–20-year-old rates increased from £8.60 to £10.00, representing an increase of 16.3%. 16–17-year-old rates rose from £6.40 to £7.55, representing a bump of 18%. This is the highest boost to NLW since 2001 and is expected to generate a major impact on bottomline earnings for most retail businesses.
The Low Pay Commission estimates that there were around 1.6 million workers paid at or below the minimum wage in April 2023, around 5% of all UK workers. Jobs paid around the minimum wage are concentrated within retail, hospitality, and cleaning and maintenance occupations. Consumer focused businesses represent 16% of the London Stock Exchange. As a result, it is safe to say that many top UK publicly listed businesses that employ minimum workers will have to adjust in a way to avoid taking hits on their profits, in order to maintain or increase their share prices.
NEXT PLC and National Living Wage (NLW) Increases
NEXT’s trading statements are a joy to read for any consumer investor as they provide insights into trading patterns and operating conditions that can be used as cross reads for other UK retail peers. The January trading statement gave a break down on Profits using a walk forward analysis. Using this, investors can figure out where profitability will be at year end and how they should model movements. Breakdowns can also be used as reference points for cost modelling, if an investor is bullish on the business it can choose to project lower values than what NEXT guides for and vice versa for those that are bearish.
From the table above, it is clear to see the biggest driver affecting profitability is Wage Cost Inflation. According to the company, the change is driven by a combination of general wage inflation, NLW increases, decrease in Employer National Insurance threshold, and increase in ENI headline rate. The rise in NLW in the last decade is around 88% whereas general inflation has been around 35%. This means that NLW increases spear through the several pay levels above it. For this reason, NEXT maintaining wage differentials between minimum wage workers and higher responsibility roles will cost as much as the increases of NLW itself.
Other firms will experience similar affects with salaries increasing across the board. Using this insight, we can predict that firms that pay above minimum wage for their lowest paid workers will also see salary increases as rates offered by competitors will become more competitive.
The scale of NI increases is significant due to the change in threshold for part time work. Part time work is costlier on a disproportionate basis than full time work. This is where UK firms will be hit the most if they choose to retain part time workers. Additionally, the threshold for NI contributions has been lowered from £9,100 to £5,000, bringing in many lower income and part time workers into the system. This is another way firms will be impacted by the changes. According to Ashdown Group, any business that has more than 6 employees will be paying higher national insurance than before.
Mitigation Plans
There are 2 ways costs can be offset: price increases or cost reduction. NEXT is planning to do both. Selling prices will rise by 1% on a LFL basis over and above factory gate price increases. Currently the company is seeing 0% inflation in factory gate prices. This is expected to grow gross margins as prices are expected to grow below the Bank of England’s target of 2%. Cost wise, this will offset £13 million of wage costs.
Another way NEXT will mitigate the rising costs is through adapting to customer trading patterns. Currently, less entry level products are being purchased, and middle and higher tier items are being preferred. Average basket sizes are lower but average spend is slightly higher YoY. As a result, the overall average selling price of goods will increase by more than 1% which is expected to deliver labour cost savings across the whole business.
The final way costs will be mitigated is through operational efficiencies. This is expected to total £23 million through improved working practices and operational efficiencies in warehouses, distribution networks and stores. Warehouse improvements come as a result of improvements in technology. With higher unit selling prices caused by changes in customer trading patterns, the cost of handling each unit relative to its value, and in doing so reduces Opex % revenue.
Extendibility of NEXT’s Strategy
NEXT PLC is a great example of how legacy businesses in the UK can mitigate the rise in NLW. It is clear to see the impact largely stems from part time worker rises in NI. On the revenue side, firms can improve their unit selling prices by either increasing selling prices above inflation or selling higher priced items as part of the product mix. On the cost side, reliance on part time workers can be reduced through technological improvements in warehouses where customer facing staff are not needed.
NEXT has some pricing power which allows it to remain competitive by increasing prices at a low level. For example, restaurants which tend to employ a high number of minimum wage workers will become uncompetitive if they were to match the NLW increases. Greggs is one example which has a customer base which is very price sensitive. They simply can’t expect customers to purchase pricier items and can’t increase average unit selling prices as a result. For most items, they will be forced to absorb some of the cost which will negatively impact unit economics on menu items, leading to decreased profitability.
Conclusion
A lot of publicly listed UK firms have been affected by the new budget policies. Some firms already pay above minimum wage like Tesco and will not have to worry about wage inflation when considering prices. Firms like NEXT will have to consider the impact but have the tools to mitigate the changes. Most non-F&B companies will have the ability to average out their cost basis through increasing average unit selling prices. However, it is worth analysing the exposure to minimum wage workers of any UK firm that one holds in their portfolio. NEXT is an example of how a firm can ease market worries considering its share price spiked by 3.5% when the most recent trading statement was released. I am confident, quality UK names will be able to counter the wage increases and investors should look at picking up these companies for cheap prices caused by markets overreacting to the wage increases.
Sources
https://moiglobal.com/mark-walker-202107/
https://researchbriefings.files.parliament.uk/documents/CBP-7735/CBP-7735.pdf
https://www.gov.uk/government/news/national-living-wage-to-increase-to-1221-in-april-2025
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