Shareholders in Debenhams (LON:DEB) were in for another disappointment again today as it posted yet another profit warning. The share price has nowhere left to go now, perhaps indicating that most of this news was priced in:
Remarkably even this 1 year shot where the price has declined from 30p to 3p does not show the full picture. Just over a decade ago, the shares were worth over 200p and even as late as 2016, the price was in the 75p range. It has been a literal slow-motion car crash. As we can see today, the market cap of the whole company is just £36m.
Debenhams has not been covered before on the site, but it has only been a matter of time. There is no real introduction needed to this business or what it does: a chain of high-street department stores whose best days have been in the past. Its success and demise are very easy to understand: originally department stores were highly desirable as a place to get multiple items under the same roof. Internet shopping has robbed most business away, undercutting on price, sometimes heavily so.
What is left is a business with high fixed costs, employing too many people in stores that are too large. The sales that they do have left are not sufficient to arrest the trend. This isn’t a business specific thing, as House of Fraser, Mothercare and Toys ‘R’ Us have all experienced the same thing.
Profit warnings have been a constant part of Debenhams’ recent history with a variety of initiatives planned to buck the trend. So far, none seems to have worked.
The warning appears in a 7.45am trading update: no particular reason why it could not have come out at 7am, but it’s better than a mid-day one as we have seen from others. This covers trading for the 26 weeks to March 2.
Perhaps the first part is not bad:
As set out in the trading statement of 10 January 2019, the first 18 weeks of our financial year saw Group gross transaction value (“GTV”) decline (5.6)%, with LFL down (5.7)%. The UK was down (6.2)% with International down (3.5)%. Digital sales grew by 4.6% across the period.
In the subsequent eight weeks, Group GTV has moderated its decline to (5.0)%, with LFL of (4.6)%. Overall, for the 26 weeks of H1, to 2 March 2019, Group GTV has declined (5.4)%, with LFL of (5.3)%. The UK was (6.0)% with International down (2.3)%. Digital sales have grown by 2.0% across the period. The annualised £80m cost saving programme is on track, and we expect the first ranges resulting from our sourcing partnership with Li & Fung will be in stores in the current season.
Sales are falling, but the rate of them is slowing. Although to be fair, this decline then gives softer comparables to work with going forward.
Further to our announcement of 12 February regarding the additional £40m bridge facility, discussions with stakeholders have now progressed to include options to restructure our balance sheet in order to address our future funding requirements, and are continuing constructively.
This must mean a debt-for-equity swap, although given the value of the company today they might need quite a lot more.
While trading headwinds have moderated in recent weeks, this process is likely to be disruptive to our business in the coming months. Taken together with macroeconomic uncertainties and increased financing costs as a result of additional working capital needs, this means that the Group’s statement made on 10 January that we were “on track to deliver current year profits in line with market expectations” is no longer valid. We will provide a further update with our interim results announcement.
It is not stated what these are (a quick check on Research Tree shows an estimate of £9m) but even worse there is no guidance of what profits there will be, if any.
A look at the share price history will tell you that Debenhams are in a poor state, and with short interest still at over 10% even at these depressed levels of pricing, some may have an opinion that this is the end game. Even now, they are in the process of becoming a smaller business, with over 50 stores set to close in the medium term and perhaps even more in the future.
Even visiting a store will give you the impression that they are uneconomic – most stores are vast spaces which are not incredibly busy, often retailing brands of clothes that either are non-premium or could be had elsewhere. The homeware section (often the top floor) is in my view much of a disaster, with expensive goods that can be bought cheaper online nowadays.
But even so, these figures from Stockopedia only point to a recent downturn: the share price decline was pricing in the bad future that lay ahead. Even the 2017 figures of £48.8m were after exceptional charges, most of these will become unexceptional in the near future as stores are closed and Debenhams is ‘transformed’.
The trouble is that the shocking 2018 figures included a £500m lease impairment charge – something that has been coming for quite a long time, and almost negates what has happened in the previous years.
The debt levels here indicate a real sinking ship: debt has stayed constant at a large £321m, and on a backdrop of reduced profits will almost certainly require the co-operation of lenders to continue. Everywhere you turn to they in a tight spot: the CEO Sergio Bucher earned almost £1m last year – a generous pay packet for a company of this size, but arguably one would need to offer a good deal for anyone to join.
As we can see here, there is £20m in interest to pay a year, and with a renegotiation of the maturing facility likely to cost even more. An announcement in February gave another £40m with a waiver of covenants – the price of this being the cost of the loan being LIBOR + 5% and rising.
The cash-flow statement is not pretty, with the drawdown of another £66m of debt and a favourable working capital movement allowing some breathing space. In effect, the business is being virtually funded by its suppliers, which have extended it over £600m of credit between them.
Bucher’s last roll of the dice is to transform Debenhams into more of a ‘destination’ rather than a shop, and to deliver £80m in cost savings. Both of which may not be enough to fight against the fundamental trend.
Debenhams may be a fine old British brand, but there is no denying it is on its knees at the moment. The level of debt on the balance sheet will make it uninvestable for some, and there seems to be a very realistic danger that bankers will simply pull the plug if sufficient progress is not made, or if the new store concept bombs.
That said, the share price is down to such low levels that the downsides is much smaller than what it was. To me, this is a binary bet on whether the business will recover in its current form or not. If it doesn’t, you will lose all your money, but if it does, there may be some rewards.
There may be some plus points. Debenhams still generates cash, although may be in debate after the recent profit warning. A loss in footfall in the stores has been compensated by more people shopping online. There may be scope to cut out even more costs by making further concessions in its stores. Partnerships with Doddle and other coffee shops are particularly suitable.
Mike Ashley is another factor. The Sports Direct owner owns nearly 30% in Debenhams and has seen the value of his investment shrivel up. But perhaps his hard-hitting style is what is needed, and he has already shown his teeth, ousting the chairman and CEO from the board.
The most likely avenue may be the same one that Ashley took with House of Fraser: a CVA, which would allow it to renegotiate its obligations, particularly with regard to its stores which would allow fast closures. A massive rights issue may be needed in the future to repair its balance sheet which may still dilute investors heavily. From an investment point of view I think it is too risky. 1/5.