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Heritage British brand is in ‘Catch-22’ situation, says broker

Heritage British retail brand Debenhams (DEB) is struggling for relevance in the new world of retailing. Throw in an uncertain consumer outlook and margin pressure from weak sterling into the mix and former Amazon executive and new CEO Sergio Bucher has his work cut out in reviving the department store.

Bearish Berenberg

Structurally challenged Debenhams, a surprise festive winner, is re-balancing its business away from fashion while rolling out concessions to fill ‘under-optimised space’. Investment bank Berenberg is unconvinced.

In a research note published ahead of April’s half-year results and strategy update from Bucher, Berenberg downgraded its rating from ‘hold’ to ‘sell’ with a 46p price target. Debenhams currently trades at 54.78p.

‘We believe its UK market share and top-line growth are under threat, hindered by an undifferentiated customer proposition to that of peers in an increasingly competitive market,’ write Berenberg’s retail analysts. ‘Debenhams is also severely structurally challenged by prohibitively long store leases, which restrict it from adapting to declining footfall and the transition of sales online.’

Inferior proposition?

Alarmingly, UK store like-for-like sales have declined for four consecutive years amid cut-throat competition and with its online growth cannibalising store sales. Berenberg sees top line growth slowing given what it believes is an ‘inferior customer proposition’, rising competition in health and beauty and the department store model losing relevance in retail.

Restructuring Debenhams’ ‘very inflexible store estate’ with 20 year average lease lengths is the biggest challenge facing Bucher. ‘We believe it is in a Catch-22 situation, forced to continue to invest in stores which are in long-term structural decline, leading to falling ROIC (return on invested capital) and margin erosion,’ explains Berenberg. It estimates ‘average lease break costs could be in the region of circa £15m’, heaping further pressure on Debenhams’ cash flow and posing a risk to dividends.

For the financial year to August 2017, Berenberg forecasts pre-tax profit of £102m (2016: £114m), ahead of a further drop to £90m in 2018. Based on this year’s 6.6p earnings per share estimate and flat forecast dividend of 3.4p, indebted Debenhams trades on a prospective price-to-earnings (PE) ratio of 8.2 with a 6.25% dividend yield.

The shares are cheap for a reason, though Berenberg does caution: ‘New CEO Sergio Bucher will leverage his previous online and merchandising experience to try to reinvigorate Debenhams’ customer proposition. If he achieves this faster and more cost effectively than we anticipate, it would pose a risk to our (negative) investment case.’

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