A third profit warning in six months increases our fear that the dividend of high street department store Debenhams (DEB) could soon be pulled and that shareholders could face further capital losses. The department store chain started the year by reporting a disastrous Christmas trading period, and has followed up with two profit warnings since. While it is cutting capital expenditure and attempting to revamp stores, the entrenched nature of the downward earnings trend and the structure of Debenhams' cost base means we think investors would be best off out of it.
Digital growth
Focus on cash
Third profit warning
Poor start to summer
Tough apparel market
Punitive level of fixed costs
An increasingly competitive apparel market in the UK, where market share is being taken by high-end and online retailers, has contributed to a poor start to the spring/summer season for mid-market Debenhams. Like-for-like sales are down roughly 2.1 per cent year-to-date, while an increase in promotional activity means an expected decline in annual gross margins has worsened by another 50 basis points (bps) to 150bps. In fact, based on forecast "gross transaction value", such a margin decline represents a hit that is slightly more than the £42m paid out as dividends last year.
The earnings pain is being increased by the company's high fixed costs, which last year included £221m of rent. Indeed, large long-term property lease commitments seriously impinge on Debenhams' financial flexibility. Non-cancellable operating lease commitments stood at £4.5bn in the last annual report, over half of which stretch out beyond 10 years. Meanwhile, models used by broker Liberum indicate that Debenhams' profits are more sensitive to sales declines than any other listed retailer, and the broker estimates that profits now only cover the business's fixed charges, such as rent and interest, by 1.2 times.
Following the most recent warning, pre-tax profit is expected to be in the range of £35m to £40m for the year, a significant downgrade from previous consensus estimates of £50m. This has further entrenched a long-term downgrade cycle (see graph) that has seen 2018 and 2019 EPS forecast in the year to date drop by 49 and 44 per cent, respectively.
Management now plans to focus on cash generation – a sensible enough idea – by curtailing capital expenditure plans, by at least £50m taking spending to between £90m and £75m. However, to cut spending at the same time as winning customers back from high-street and online rivals will be a tough balancing act, even if its own recent web sales growth is encouraging. Debenhams will also need to pay its landlords before taking care of shareholders, which makes us believe that the dividend is under threat. Analysts at Peel Hunt, whose forecasts are used in the table below, are among those that agree (by no means every broker has given up on the dividend) pointing to the difficulty in justifying a curtailment of capital expenditure plans only to meet dividend commitments – especially when the business needs such a dramatic, strategic overhaul.
DEBENHAMS (DEB) | ||||
ORD PRICE: | 16.7p | MARKET VALUE: | £205m | |
TOUCH: | 16.6-16.7p | 12-MONTH HIGH: | 51p | LOW: 16p |
FORWARD DIVIDEND YIELD: | nil | FORWARD PE RATIO: | 7 | |
NET ASSET VALUE: | 73p* | NET DEBT: | 28% |
Year to 31 Aug | Turnover (£bn) | Pre-tax profit (£m)** | Earnings per share (p)** | Dividend per share (p) |
2015 | 2.86 | 114 | 7.6 | 3.4 |
2016 | 2.90 | 114 | 7.5 | 3.4 |
2017 | 2.95 | 95.2 | 6.3 | 3.4 |
2018** | 2.91 | 34.6 | 2.3 | 0.5 |
2019** | 2.93 | 37.6 | 2.5 | nil |
% change | +1 | +9 | +9 | - |
Normal market size: | 20,000 | |||
Beta: | 0.27 | |||
*Includes intangible assets of £995m, or 81p a share | ||||
**Peel Hunt forecasts, adjusted PTP and EPS figures |