Debenhams boss Sergio Bucher says the department store group has “a successful and profitable future”, but will the redesigned business be more or less profitable?
The much-awaited Debenhams strategic update today overshadowed the interim results, but they were said to be “in line with expectations”, with pre-tax profits down by 6% to £87.8m.
The implication is that Debenhams, like other department store chains with a heavy fixed-cost base and weak sales, is running up a down escalator in terms of profitability.
So the emphasis in the new strategy, ‘Debenhams Redesigned’, on delivering “growth” (“by becoming a destination, digital and different”) and driving “efficiency” (“by simplifying and focusing our business”) sounds positive.
All this, inevitably, will require more capital expenditure and more exceptional costs.
The City, which would prefer Debenhams to focus on increasing its dividend payout, didn’t like the sound of that.
More significantly, Debenhams failed to take the opportunity to offer shareholders any sales or profit targets against which the new strategy programme should be judged. That is disappointing.
Of course, sometimes it is best to keep your powder dry and try to surprise on the upside, rather than lose credibility by setting unrealistic expectations.
“Perhaps it goes without saying that growing sales in the current highly competitive marketplace will be difficult”
That was a trap the new chief executive of Marks & Spencer, one Marc Bolland, fell into in 2010, when setting out overly ambitious sales growth targets for the business.
Perhaps it goes without saying that growing sales in the current highly competitive marketplace will be difficult.
That makes the issue of profitability even more important because increasing gross margins will also be difficult, even though Debenhams is slowly losing its reputation for being “Never Knowingly Not on Sale” and reduced its discounting.
The problem is that operating costs are only going up, and squaring that P&L circle is a conundrum for even the best operators in bricks and mortar retailing.
Department stores are particularly challenged because their big stores bring a very heavy level of fixed costs, and losing store sales to online shopping only causes more operating de-leverage discomfort.
Debenhams is somewhere in the middle of the profitability range. It achieved a 5.6% operating margin in the first half, but that is seasonally flattering and it makes little money in the second half (with an August year-end).
But on an annual basis the profitability trend is clearly downwards: the operating margin was 4.7% in full-year 2015, 4.4% in full-year 2016 and looks like being only about 4% in full-year 2017.
Lack of details
Sergio Bucher is very capable of injecting more excitement into Debenhams’ store design and improving its online offer, but the world is not standing still and all its competitors are trying to do much the same thing.
It was all the more disappointing that Bucher didn’t address the fundamental economics of the business today, even though the new strategy is said to be “grounded in reality”.
“The share price reaction, down over 5% to 52p at the time of writing, reflects the air of disappointment”
When pressed, management said today that they will provide more detail on financial targets in October, with the final results, and that they expect profits to increase over the five years of the new plan, but to a cynical City that hardly sounded like a ringing endorsement.
The share price reaction, down over 5% to 52p at the time of writing, reflects the air of disappointment and, needless to say, Debenhams has been a very poor investment in recent years.
The share price is no higher than it was when the previous chief executive Michael Sharp took over in September 2011, so investors would have hoped that Debenhams’ management could have offered a more convincing story today.
Mike Ashley is watching
One person who will be following all this very closely is Mike Ashley, because Sports Direct has built up a big stake in Debenhams.
There may be just a commercial relationship angle to the stake, but it has not obviously made him any money so far.
He has publicly ruled out making a bid for Debenhams, but then the prime minister ruled out a snap general election, so people do change their minds.
Whether Mike Ashley will change his mind about Debenhams and what he would do differently remain to be seen.