Why a bidder is unlikely to put Debenhams’ shareholders out of their misery

“Eight months after launching his Debenhams Redesigned strategy, Sergio Bucher, the company’s boss, must be wondering what he has let himself in for by taking the job, as today’s huge profit warning means it looks more like a case of Debenhams Undone,” says Russ Mould, AJ Bell Investment Director.

“While eight months is not a fair time period by which to judge any strategy, it is clear that a combination of Debenhams’ historic reliance on its ‘Blue Cross’ price promotions, excess floor space and a web offering that needs more work are combining to confound the Bucher plan.

“Even though digital sales showed a welcome 9.9% year-on-year increase in the last 17 weeks of the year, UK like-for-like sales still fell 2.6%, forcing the group to go back to its old discounting ways. As a result, first-half gross margin is expected to drop by 150 basis points (1.5%), way in excess of the 25 basis point drop for the whole year forecast by management alongside the full-year results in October.

“The combination of weak sales and lower margins means Mr Bucher now expects pre-tax profit to reach only the £55 million to £65 million range, compared to analysts’ forecasts of £80 million and last year’s (pre-exceptional charges) figure of £95 million.

“The latest drop in annual profits will only add to a grim sequence of declines which makes it clear just how serious Debenhams’ competitive position really is.

Debenhams

Source: Company accounts, Digital Look. *2017-18 based on revised company guidance on 4 January 2018

“Unlike Next, Debenhams was slow to adapt to the online world, has previously failed to focus on full-price sales (although Mr Bucher is now trying to fix both of these now) and its large format stores are not sufficiently local or convenient for customers to use them as click-and-collect stops.

“Worst of all, Debenhams is locked into some very long-term leases.

“The company ended its financial year in September 2017 with just £9.3 million in property on its balance sheet, so there is little asset backing to the balance sheet with which to tempt a bidder, while the company’s lease expenses on its store estate, warehouses and offices and properties came to £221 million in 2016-17.

“Future payments on existing leases (described in the 2017 annual report and accounts as “non-cancellable”) are estimated to be £4.5 billion, based on current terms and conditions.

“This is a considerable burden on the company and one that investors must take into account as they ponder whether Debenhams’ shares are now looking very cheap or are nothing more than a classic value trap. Such liabilities are likely to deter anyone from viewing Debenhams as a potentially cheap acquisition, even if on the face of it the shares come with a tempting valuation.

“Based on the company’s new pre-tax profit guidance and a 20% tax charge, Debenhams looks set to make earnings per share of 3.9p. That puts the company of a forward price/earnings ratio of 7.5 times, with a dividend yield on a 29.8p share price of 11.5%, assuming the payout is unchanged at 3.425p - although the market is clearly already discounting a dividend cut as an 11.5% dividend yield is not a credible proposition.”

Debenhams (£ million) 2017-18 E
   
Operating profit (before lease expenses) 72
Depreciation and amortisation 115
Tax (20)
Capital investment (150)
Cash flow 17
   
Dividend (42)

Source: Based on company management guidance given in October 2017 and January 2018

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