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Sports Direct - Debenhams stake sends profits crashing

Nicholas Hyett | 19 July 2018 | A A A
Sports Direct - Debenhams stake sends profits crashing

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Frasers Group plc ORD GBP0.10

Sell: 887.00 | Buy: 888.50 | Change -14.50 (-1.61%)
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Full year revenues rose 3.5% to £3.4bn, boosted by acquisition of Bobs Stores and Eastern Mountain Sports in the US.

The group says underlying profits rose 57.7% to £104.9m, but losses on strategic investments, including in Debenhams, and lower margins, meant reported profits after tax fell 88.1% to £27.6m.

The shares fell 10.5% in early trading.

Update - 10/08/18

On 10 August Sports Direct announced that it had acquired House of Fraser for £90m, after the department store went into administration.

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Our View

With Sports Direct, it's always a challenge to focus on the business and not the media circus surrounding it. This time it's the £85m loss on Debenhams shares, a confusing position the group topped up in March, that's attracting the headlines.

Unfortunately the lack of transparency also seems to stretch to the "Selfridges of Sport" initiative.

The strategy calls for new freehold 'flagship' stores, displaying products in a more flattering environment. A better store environment should, in theory, allow the group to charge more for its products and heal Sports Direct's troubled relationships with the major sports brands as well.

The new format stores are said to be "exceeding expectations", but it's difficult to see evidence of that in the numbers. Improvements in underlying profits are being driven by cost cutting rather than sales growth - which is actually negative in the UK - and gross margins are down.

'Elevating' the store estate isn't coming cheap either. While the group generates plenty of cash, and at 1.1 times EBITDA is far from heavily leveraged, debt is climbing rapidly.

Sports Direct hasn't paid shareholders a dividend since 2010 - arguing that the money could be more usefully invested back in the business. It's difficult to reconcile that with the recent buyback programme, particularly since the shares are now trading on a PE ratio of 21.4 times, compared to a long term average of just 13.4 times.

At the heart of Sports Direct is an impressive and attractively cash-generative business. But our concern is that attention isn't fully focussed on turning round the core operations. Two struggling sports chains in the US must be demanding disproportionate amounts of management attention, and America has been something of a graveyard for UK retailers. Added to that is an eclectic, and growing, collection of 'strategic investments' - which has ended up costing the group several tens of millions this year.

Combined with a corporate governance record that's erratic at best, there are plenty of reasons to be cautious where Sports Direct is concerned.

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First Half trading details

Sports Direct's core UK retail business saw revenue fall 2% year-on-year to £2.2bn - or 0.3% once the effect of a 53rd week in the last financial year is excluded. UK like-for-like (LFL) sales fell 0.6%.

Revenues in the European business were flat at £637m, despite the closure of 11 stores.

The tough UK environment was partially offset by a 595% increase in Rest of World sales, which now stand at £192m, following acquisitions in the US. The Premium Lifestyle division, which includes luxury fashion retailer Flannels, also put in a strong showing, with sales up 42.7% to £162m.

Gross margin across the group fell 1.3 percentage points to 39.7%, with declines across all divisions largely driven by investment in more expensive stock.

The strategic investment in Debenhams, where Sports Direct own a 27.9% stake, resulted in an £85.4m net loss during the year.

Despite the headwinds facing the group, free cash flow increased 26.7% to £326m. That's funding the group's strategy of acquiring freehold properties to improve its store estate, with £140m spent on property this year.

£114m of share buybacks and strategic acquisitions mean that, despite the improved cash flow, net debt still more than doubled to £397.1m.

Find out more about Sports Direct shares including how to invest

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

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