Debenhams PLC (LON:DEB) is facing structural challenges as it has been slow in catching up on the online retail shift and has been slashing prices to lure in customers, according to analysts.
The department store chain issued a profit warning after reporting a 1.8% decline in like-for-like sales in the 17 weeks to December 30, blaming tough competition and a volatile market.
READ: Debenhams blames competitive retail market as it reports drop in quarterly sales
It said it expects pre-tax profit of £55mln to £65mln for the year against analysts’ estimates of £83mln, compared to adjusted pre-tax profit of £95mln last year.
The company said margins have come under pressure as it responded to competitor discounting by offering more promotions to attract customers in a “challenging” retail market.
Shares plunged more than 20% to about 28p in morning trading.
Structural challenges
“Ongoing structural challenges, a soft consumer environment, rising costs and increasing capital expenditure demands make for a difficult outlook, in our view,” Liberum said as it repeated a ‘sell’ rating and cut its target price to 25p from 40p.
Analysts at Numis advised investors to “continue to avoid” the stock, reiterating a ‘hold’ rating and target price of 30p.
“Having been using the same line since 2013 we risk sounding like a broken record, but we cannot see past the severe structural pressures facing Debenhams - cost and share implications of online shift, low margins, long leases, high capital expenditure requirements, low returns, margin pressure from mix - particularly with the net debt to EBITDA ratio now also increasing notably,” it said.
Amisha Chohan, equity research analyst at Quilter Cheviot, also thinks Debenhams is “structurally challenged” and believes its dividend may be at risk.
“We continue to believe Debenhams is structurally challenged by a customer proposition lacking differentiation and an inflexible store estate (average lease 19 years), forced to continue investing in online assets, which typically deliver a lower return,” Chohan said.
“The dividend may also be at risk, due to an increase in investment in the business.”
Debehnams 'slow to adapt to the online world'
While the group achieved a 9.9% increase in online LFL sales growth and a 2.6% rise in international sales over the 17-week period, this was offset by a 2.6% decline in UK sales.
Traditional brick and mortar retailers like Debenhams have been late in responding to the growing trend towards online shopping.
Recognising the need to invest in its digital offering, Debenhams poached Amazon executive Sergio Bucher as its chief executive in October 2016 to introduce an online strategy.
“Debenhams was slow to adapt to the online world, has previously failed to focus on full-price sales (although Mr Bucher is now trying to fix both of these now) and its large format stores are not sufficiently local or convenient for customers to use them as click-and-collect stops,” said Russ Mould, AJ Bell investment director.
Bid for Debenhams seen as unlikely
Mould added that Debenhams is locked into long-term leases with a lack of property assets with which to tempt any bidders to put “shareholders out of their misery”.
The company ended the last financial year with just £9.3mln of property assets on its balance sheet and lease expenses on its store estate, warehouses and offices and properties came to £221mln.
Future payments on existing leases are estimated to be £4.5bn, based on current terms and conditions.
“This is a considerable burden on the company and one that investors must take into account as they ponder whether Debenhams’ shares are now looking very cheap or are nothing more than a classic value trap,” Mould said.
Next vs. Debenhams
The Christmas trading statement from Debenhams is a stark contrast to a similar update from Next on Wednesday when it surprised the market by raising its profit forecast.
Next said it expects full year profits to rise by £8mln to £725mln after full price sales rose 1.5% between November 1 and December 24, driven by online sales growth and the cold weather.
READ: Next shares boosted by full year profit forecast hike after unexpected rise in Christmas sales
“On Wednesday Next’s trading update hinted that the retail environment might not be as bad as feared, though the latest announcement from Debenhams illustrates the danger of drawing too many conclusions from a sample of one,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.
“By this time next week we should have a much better idea of how the retail industry and the UK consumer is doing, with the likes of M&S, John Lewis, Tesco and Sainsbury handing in their Christmas scorecards.”
Digital channels the 'only winners' in retail
But there is only one certain winner in this season’s retail sector results - the digital sales channel, Khalaf said.
“It’s telling that the market celebrated 1.5% sales growth from Next, while online retailer ASOS is growing sales by over 30% a year.”