The Debenhams (LSE: DEB) share price climbed by as much as 16% on Thursday morning, after the company announced plans to close 50 stores and cancelled its dividend.
Are investors right to cheer these results, or should we stay away as chief executive Sergio Bucher fights to keep the department store group afloat?
I’ve been looking at today’s numbers to decide whether to invest.
Profits down 65%
The year to 1 September was a bad one for Debenhams. Underlying pre-tax profit fell by 65% to £33.2m, while sales fell by 2.5% to £2,277m.
The group’s underlying operating profit margin dropped from 4.6% in 2017 to just 1.9% last year.
Unsurprisingly, the dividend has now been cancelled. I wouldn’t expect a payout for the foreseeable future.
Store headaches
In a presentation to analysts today, the firm said that 10 stores were now loss-making and that 110 stores are “over-rented”.
What this means is that Debenhams is paying more than the current market rent for the store space. The firm is a victim of the UK system of upward-only rent reviews on commercial property leases. Until the lease is renewed, the rent can’t be cut.
Unfortunately, the firm’s stores have an average of 18 years remaining on their leases.
To try and improve the situation, the company will focus on upgrading the 100 most profitable stores. These are said to account for 80% of sales and more than 80% of profit.
A further 20 stores will be optimised — basically run as cheaply as possible, hopefully with rent reductions.
About 50 stores are earmarked for closure over the next three to five years. This is likely to be expensive — the company announced a charge of £117.5m for “store impairments and onerous lease charges” today.
IOU
The other big concern for me is debt. Net debt rose by £45.4m to £321.3m last year. That’s 2.1 times earnings before interest, tax, depreciation and amortisation (EBITDA).
I usually look for a maximum of 2x, so this doesn’t sound too bad. And new finance boss Rachel Osborne is targeting an extra £50m of cost savings by 2020 to help prevent debt rising further.
However, I’m not convinced that these sums will add up. In each of the last two years, Debenhams has spent about £100m on store upgrades and other developments. The firm has also spent about £30m on essential capital expenditure such as maintenance.
Despite this, only nine stores are trading in the new format. So another 91 are still due to be upgraded. I don’t see how this can be completed without debt rising further.
Signs of hope?
One positive note in today’s results was that the firm’s new-format stores are said to be trading better than comparable old-style stores. Additional food and drink concessions are also said to be performing well.
Internet growth continues, with digital sales up 16% during the second half of the year. Fashion rival Next reported a 16.8% increase in online sales over roughly the same period, so I guess that’s a respectable figure.
However, Debenhams said today that it expects “no improvement in the trading environment for the foreseeable future”.
My view is that this business will probably survive, but it’s likely to need an injection of fresh cash at some point. This could be highly dilutive for shareholders, so I’d avoid this stock for now.