Gamble of the week: down-trodden department store

published 13 January 2014

Last year I tipped this compnay, thinking that it was one of Britain's better retailers. I was wrong. The shares have been a terrible investment, with two profit warnings in the last year.

The company has had a bad Christmas. It has had to slash prices to keep sales at the same level as last year, but it still has too much stuff left over to sell. This means there will be lots of big discounts on offer in January and February. That's bad news for profits.

If you needed a good example of how some retailers' profits are very sensitive to small changes in margins, then this one fits the bill. By cutting prices, its gross profit margin will fall by around 1%, yet pre-tax profits are expected to fall by a quarter for the first six months of its financial year.

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Sales of beauty products and homeware have been reasonable. The big problems have been with clothing. Something seems to have gone badly amiss.

Debenhams

Debenhams blames heavy promotional activity on the high street, but this hasn't stopped the likes of Next, John Lewis and House of Fraser from doing well. This is what has worried the market. That said, Debenhams is not likely to go bust.

Debenhams had net debt of £372m in August, but its ability to pay its interest bills and the rents on its shops is still quite comfortable. The key issue is whether it can get its business back on track and start growing profits again.

It needs to become more focused and start selling more online for starters. Sentiment towards the company is very poor right now, but this looks priced into the shares. At 76p, they trade on 8.6 times this year's reduced profit forecasts, while offering a well-covered dividend yield of 4.3%.

You could argue that that's about right for a company in a competitive sector with much to prove, but if Debenhams can fix its problems then the shares have the potential to bounce higher.

Verdict: a risky punt

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.

After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.

In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.