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Debenhams - Shares rise as profit hits guidance

Equity research team | 27 October 2016 | A A A
Debenhams - Shares rise as profit hits guidance

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Shares rise as profit hits guidance

Debenhams has delivered a solid performance this year, delivering results in line with market expectations. The group's final dividend of 2.4p per share means the full year dividend is up 0.7% on last year. The shares rose by 3% on the news.

Our View

After more positive trading updates earlier this year, Debenhams has managed to meet profit forecasts. That's despite following in the footsteps of larger rivals Next and Marks & Spencer and falling foul of the tough conditions in the UK's clothing retail sector.

Debenhams has looked to move away from the famous 'Blue Cross' discount model, in the hope of boosting profit margins. However, getting shoppers to spend on the high street is difficult enough just now, and Debenhams has found it even harder when their customers are not getting the discounts they are used to.

The group has other challenges too, not least countering the threat posed by a weaker pound. With 35% of sourcing costs in US dollars or dollar-linked currency, the group may well feel the pinch once their currency hedges run out in a year or so. Margins could come under pressure if the group holds prices level to stay competitive.

Optimising the space in their large store estate is also an issue, and the group will introduce new brands and more casual dining facilities. Although debt is falling, overall levels are still above targets, and the group has significant leasehold obligations.

With the above challenges in mind, Debenhams is one of the lowest-rated retailers that we cover. The stock trades on 7.7x forward earnings and offers a prospective yield of c6.5% next year.

However, in recent times outgoing CEO Michael Sharp has made some useful strategic calls, in particular to hold lower levels of seasonal stock, and to invest in a multi-channel retail strategy. Progress in online and mobile has been strong, and these now represent 15% of total revenue. With Sergio Bucher of Amazon's European fashion team taking over, the focus on digital and online looks set to continue, but analysts will need to wait until next year to hear his plans in full.

Full year results in detail:

While like-for-like sales in UK stores edged down slightly, new sales space and growth in online sales helped gross transaction volumes increase by 1.3% to £2.9bn. The group reported a £114.1m increase in underlying profit before tax, a small increase on last year and in line with market expectations.

While the clothing market deteriorated through the second half of the year, growth was delivered through strong performances in beauty, gift, swimwear and food, which will see increased roll-out plans to pick up on the casual dining opportunity. Despite the group continuing to reduce promotional activity in clothing, the changes in product mix reduced gross margin by 10bps.

Debenhams continues to develop its multi-channel proposition, with online sales up 9.3%. Mobile now accounts for over half of all online orders.

The group continue to manage their costs tightly and has mitigated the additional £3m cost of implementing the National Living Wage through various productivity initiatives including reorganising its supply chain.

Net debt fell by £40.8m to set to £279m. The group expect this to fall to c.£260m next year. Debenhams also target improving gross margins by 25 bps.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.