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Debenhams is a United Kingdom retail department store business based within the 'general retailers' sector of the consumer services industry as defined by the Industry Classification Benchmark (ICB 2012). The start was with a draper store established by William Clark in 1778, then William Debenham invested in the company in 1813 and it became Clark & Debenham (Debenhams 2012).
Debenhams Ltd. was incorporated later on in 1905 and became largest department store in the UK by 1950. The move to the Republic of Ireland was with acquisition of nine Roche department stores in 2007 followed by the acquisition of the top department store chain in Denmark in 2009. Debenhams is now one of leading British international brands operating through 240 stores through 28 countries and online presence in 70 countries (Debenhams 2012).
Debenhams' normal operations are the trading of clothing and homeware in addition to health and beauty products (Financial Times 2012) . In 2006 Debenhams declared their intention to offer its public shares and to be traded on the London Stock Exchange after a two year absence which was the result of the company being bought by a consortium of private equity companies (The Guardian 2006).
1.1 Trend Analysis
1.1.1 Five years Income Statement
To analyse the company performance, a trend analysis is used. The five year summary highlights the company's performance over this period. Firstly the consolidated income statement illustrates the profitability of the Debenhams Plc. Here it shows that Debenhams Plc was a profitable business over the five years. Sales have constantly risen over this period. This shows that Debenhams has been increasing its market share by approximately 5% annually. The primary drivers of growth were the multi-channel business, Magasin du Nord, international sales and new UK space.
The gross profit margin has also rise. It did not increase in line with sales growth mainly because the company's sales mix has evolve over the years. This is also as a result of the decision to maximise cash profit by driving sales. This was a good result given the difficult economic environment and the fierce competition.
The rise in operating profit over this period shows that the company did manage its costs well. But we should highlight the fact that distribution costs has been increasing at an increasing rate during this period. The only exceptional costs were incurred in 2010 and 2007 for restructuring costs and they did not have significant impact on the business profitability.
Furthermore, the falling trend in finance costs point out the company's effort to bring down gearing and hence pay less interest. The steady increase in profit caused the company's tax liability to rise. Increasing profit after tax means that the business profitability has improved and more funds can be retained and be used in the business for example to acquire new Property or can be distributed as dividend to shareholders. The use of ratio enables a better assessment of the company's profitability.
1.1.2 Five years Statement of Financial Position
Secondly the group statement of financial position highlights the group financial position at the year end. From 2007 to 2011, Debenhams tangible non-current assets have consistently been rising. Growth in sales combine with growth in non-current assets over the same period means that the business has grown annually. The growth was partly financed by long term debt and current assets. We note that the company did not raise additional share capital during this period.
The negative working capital indicates that the business is financing its short term liquidity needs with long term capital. This is a bad sign for the business as it seems to persist over the years. It is worth to highlight the company's effort to reduce its gearing. The directors have recently set up a new restructuring plan to bring debt down. From an investor's perspective, we should highlight that the company has negative retained earnings. This means that the company's profits are still being used to offset the company past poor performance. A more detailed analysis would be obtained by the use of ratios.
1.2 Horizontal Analysis
1.2.1 Cash Flow Statement
Cash Flow Statement for the years ended
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net decrease in cash and cash equivalent
Net cash and cash equivalents at beginning of financial year
Foreign exchange gains on cash and cash equivalents
Net cash and cash equivalents at end of financial year
The statement of cash flows analyses changes in cash and cash equivalents of Debenhams Plc and Next Plc for the year 2010 ("previous") and 2011("current"). In 2011 Debenhams Plc generated £ 199.4 m from its day to day business activities. In comparison in the same period Next Plc generated £ 452 m. 2011 was a difficult year for the retail industry. This is highlighted by a huge fall in operating cash flow of both companies. Both companies trade cycle felt from the previous years as their inventories and receivables rise considerably and their payables felt. The decrease in interest paid for Debenhams Plc offset part of the operating cash outflow. But Next Plc paid higher tax as its operating profit rose.
During 2011, Debenhams Plc disposed its shares held in its Investee company namely Ermes Department Stores Limited (a Cyprus Company). Also, it re-negotiated its existing lease on its stores and consequently generated cash proceeds of £12.6m. In comparison in the same year, Next Plc spent more on one-off item e.g. £140 m in acquiring new property, plant and equipment. It also spent more in refurbishing its stores and increasing the trading space as compared to the previous years.
In the current year, Debenhams Plc negotiated a new credit facility to finance the payment of its existing loans. It generated an additional cash inflow of £415m. The high financing cash out flow of Debenhams Plc in 2010 reflects the part-payment of loans. In 2011, Debenhams Plc paid a dividend of £12.9 m to its shareholders. None was paid in 2010. On the other hand, Next Plc has been paying a dividend of £129.6m and £108.5 m in 2011 and 2010 respectively. Next Plc spent more than twice the amount of Debenhams Plc on financing activities in 2011. The cash was mainly used to purchase its own shares, pay interest of £21.6 m and increase in dividends.
Debenhams Plc had negative cash flows for both years. Next Plc current net outflow is more serious concern since the company had generated a net inflow of £104.3 m in the previous year. The decrease in cash in both companies over the years is mainly explained by industry factors like uncertainty of market conditions and sales growth falls. In the current year, the two companies still have positive cash balance. However, Next Plc has an overall better cash position at the end of year. A persistent net cash outflow would cause liquidity problems for Debenhams Plc in the future.
1.3 Statement of Changes in Equity
The consolidated statement of changes in equity of Debenhams presents the group's profit for the period adjusted for the effects of changes in accounting policies, corrections of errors recognised, amounts of investments, and dividends to shareholders during the period. It helps in understanding the changes in share capital and reserves.
The Statement of changes in equity shows that there were no movements in equity capital over the years. In 2010, Debenhams used its retained earnings to redeemed £303.8m preference shares. Also in 2010 Debenhams made £19.3m gains on cash flow hedge whilst in 2011 it loss £7m. In the current year, Debenhams Plc use its reserve to amortise the sale of its investment. The additional increase in 2011 is explained by gain £75.8m on actuarial on pension schemes. It should be noted that Debenhams paid a dividend of £12.9m in 2011.
In comparison, over the same period, Next Plc was more active on equity transaction. It annually bought and cancelled its shares from the market as decided by the shareholders. Also, Next's Employee Share ownership Trust (ESOT) holds shares in the Company as trustee of Next employees. This is reflected by the ESOT reserve. ESOT had bought 4.8m shares in 2011 (1.9m shares in 2010) at a cost of £68m (£8.7m in 2010). Furthermore, Next Plc has paid more dividends in 2011 as compared to the last year. It paid approximately 10 times the dividends paid by Debenhams in 2011.
2.0 Profitability Ratio analysis
The analysis is started by using profitability ratios. Profitability ratios is one of most frequently used measures of financial analysis which are used to fix the company's bottom line and its return to the investors. The following ratios will help us to analyse Debenhams profitability.
Net profit margin
Gross profit margin
As shown in the above table, the ROSF ratio of Debenhams in the year of 2010 and 2011 both less than ten per cent and the ratio of ROCE dramatically fell in 2011.The net profit margin declined 64bp and the gross profit margin increase 16bp respectively in the year of 2011. Moreover, it can be clearly seen that these four profitability ratios of Debenhams are all lower than Next.
The profit for the year in 2011 grew by 20.82% compared with 2010 and the drop of percentage in profit from operations between the year of 2010 and 2011 is just 3%. However, it still can be seen that the ROSF ratio have a decrease from 9.66% to 9.00% and the ROCE declined 4.8 per cent which from 18.9% to 14.1% which both due retained earnings and increase a new non-current term loan facility (Debenhams, 2011). It also shows the ratio in two years were poor, especially comparing with the Next plc. We could find that the ROSF and the ROCE of Debenhams are lower than Next. It can be seen from the financial statements that the profit of the year and the profit from operations of Next in these two years is more than Debenhams. This might be because the different sales mix and Next owns more comprehensive customer groups.
Gross profit margin and Net profit margin are interrelated with revenue closely. Revenue was 4.2% higher than last year. Group gross margin just rose slightly by 16 basis points during the year. This was partly a result of a decision to maximize cash profit by driving sales during the second half and partly some one-off benefits in last year's figure as result of the acquisition of the Faith footwear brand (Debenhams, 2011). The net profit margin shows a weaker performance compared to 2010. Combining with the gross margin, the decline of the net profit may be due to the increase in supplier price and the selling price did not have relevant change. Although the promotion of some of merchandise can make the sales to rise; it also as one of the inducements which cause the company's net profit declined.
2.1 Efficiency ratio analysis
2.1.1 Asset Turnover ratio
Asset Turnover Ratio examines the effectiveness of using assets. In 2010 for every £1 investment Debenhams made £1.94 of revenue which decreased to £1.7 in 2011, this is due to the increase in the equity by £156.2m and the huge increase in long term debt from £40.6 m in 2010 to £244.6 m although revenue increased slightly from £2119.9 m to £2209.8 m . Comparing to Next, it is obvious that Next is in better position as for every £1 invested in 2011; £3.60 in revenue was generated this was mainly due to higher sales revenue and lower equity.
2.1.2 Average inventory period (days)
For retailers inventory accounts for a big percentage of the total assets for the company, this ratio will measure how many days the inventory is being held. Debenhams had a slight increase from 59 days in 2010 to 61 days in 2011 while Next showed a better position with a lower period; 47 days in 2010 and 55 days to 2011. This might reflect a higher demand on Next products than Debenhams due to bigger loyal customer base, value to price or even advertisement.
2.1.3 Average trade receivables collection period (days)
From the analysis, credit customers took 13 days to pay what they owe to Debenhams in 2010 and 12 days in 2011 which is a more favourable short period that will enhance the business cash position than Next which had 66 days in 2010 and increased to 68 days in 2011.
2.1.4 Average payables payment period (days)
There was a decrease in the period Debenhams take to pay for supplies and services on credit from 98 days in 2010 to 93 days 2011, the big period might show that discounts could be missed but it shows also how much the suppliers have trust in Debenhams compared to Next were they have 81 days in 2011 to pay back.
From the last 2 ratios Debenhams would show an efficient cash position where customers pay them within 12 days and Debenhams pay what they owe in 93 days which means for each product they sell, they get the cash almost 8 times faster than what they pay for it.
2.1.5 Sales revenue to capital employed
Sales revenue to capital employed refers how effectively the assets of the Debenhams Plc are being used to generate sales revenue. The calculated figures show clearly that Next Plc is more effective in using its assets in both years.
2.1.6 Sales revenue per employee
Sales revenue per employee is a good measure of labour productivity. In both years, Debenhams have brought more revenue per employee than Next. Though the figure is higher, it does not necessarily means that Debenhams employees are more effective. It is merely because Next Plc employs more staff.
Sales to Employees
Sales Revenue/ No of Employees
= £2,209.8m / 30,624 = £72,159
= £2,119.9m / 30,417 = £69,695
Sales Revenue/ No of Employees
= £3,453.7m / 58,706 = £58,830
= £3,406.5m/ 55,122 = £61,799
2.1.7 ROCE as a link between Profitability and Efficiency
Profitability part (Operating Profit/ Sales revenue)
Efficiency part (Sales revenue/ Capital employed)
ROCE is an important tool for investor. Using the DuPont model, it can be divided in two sections to understand the influence of profitability and efficiency. From the above table both sections show that Next outperform Debenhams. This confirms our earlier results.
3.0 Liquidity Analysis
Measuring the current Ratio there is a significant increase of 0.2 from 2010 to 2011 though inventories increased from £295.3 m to £321.3m but it was wiped out with cash and cash equivalents decrease from £69.5 m to only £29 m which accounted for the overall decrease in current assets, but there was a big improvement in current liabilities were it was reduced from £1083.6 m to £715.6 m as Debenhams cut their bank overdraft and borrowing from £545.7 m to £168.1 m in 2011. When excluding the inventory and calculate the acid test ratio , Debenhams got a low ratio of 0.1:1 which means that current assets do not cover current liabilities and certain procedures should be done to improve the company liquidity. Comparing to next where there was a decrease in both ratios but still in a better position than Debenhams were for each £1 the business had £1.3 of current assets and £0.8 of quick assets in 2011.
3.1 Cash Operating Cycle (link between efficiency and liquidity of the business)
Operating cash cycle means the number of days for the company to generate revenues with its existing assets. This normally denotes the time between cash payment to suppliers and cash received from the sale of those goods. Operating cash cycle has significant influence on the financing requirements of the business
In this analysis, Debenhams has a negative cycle (-20 days in 2011), whilst it is 42 days for Next. The negative operating cycle of Debenhams means that it is taking too much time to pay its creditors. In the short-term it may not benefit from discount, but in the long-term it could affect the business, as the company's reputation would be affected.
On the other hand, this figure results by Debenhams having more cash sales than Next. The plus side for Debenhams is that it pays its inventory way after it sold them. Such situation is very desirable by many companies. Hence Debenhams is managing its working capital as efficiently as possible.
4.0 Gearing ratio Analysis
5.0 Investment ratio Analysis
6.0 Performance evaluation using Share price analysis
The share prices of Debenhams PLC highlight the financial of the company over the last two financial years. The graphs below show the evolution of the share prices of Debenhams Plc and Next Plc for the period September 2009 to September 2011.
2009 was a tough year for the retail industry. The poor market conditions made the share prices of Debenhams Plc to fluctuate a lot. Lack of investor confidence combined with fall in high street sales caused the prices to plumb (by 20 pence a share) in May 2010. For example, the price earnings ratio felt as share prices went down. The fall in P/E ratio sent negative signals of the company's performance. Also, the director's decision not to pay dividend kept the share prices of Debenhams Plc low in 2010.
In addition to it, share prices include the element of risk in the business. From an investor's perspective, risk is an important factor i.e. the higher the risk the more the likely the investors return on the shares will fluctuate. Over this period, Debenhams Plc share prices varied the most. This indicates there is more risk in investing in Debenhams Plc shares.
We note that the publication of information of financial result had significant effect in driving up share prices for example on 16th March 2010, 14 September 2010. On the other hand, poor trading condition caused the price to fall e.g. on 15th March 2011 and 3rd September 2011. Debenhams Plc share price reached its lowest point (at 53 pence a share) in September 2011.
Debenhams Plc index did not perform as well as its main competitors. From 2009 to 2011, the share prices of Debenhams Plc felt whereas those of Next Plc went up. Next Plc good performance was illustrated with an increase in dividend payment in 2011. Over the same period the Debenhams Plc share prices felt by 3,300 basis points overall, whilst the Ftse 250 index rose by 1,230 points. This means that both the competitors and the Industry performed better than Next. Even though the shares prices have felt recently, Debenhams Plc financial performance is not so bad. In 2011, the company profitability went up and the company has paid dividend to its shareholders. These are normally indicators of future good performance.
7.0 Possible limitations in the analysis
The ratio calculation is based on the figures from the companies' annual reports. Therefore the ratios are subject to similar limitations as the financial statements. Below is a list of limitations in analysing the performance of Debenhams Plc.
The data used to calculate the ratios are based on historical costs. In periods of high inflation, reported value of assets in the financial statements would be less than the current value.
2) Over reliance on ratios
Ratios are important tools in assessing the company's performance, but it is not the only one. Other information contained in the financial statement might help in assessing the company's performance.
3) Different financial year ends
It should be highlighted that Debenhams and Next have different financial year end. i.e. Sept for Debenhams and January for Next. Seasonal factors like December sales will have significant effect on the annual report of Next.
4) Ratios assess past performance
Ratios are calculated on past data and therefore reflect only past performance. It is difficult to assess future performance by using past data. A company will not necessary perform similarly in the future. Investors are more concerned about current and future information.
5) Ratios calculated take into account only financial performance
Non-financial factor like customer service, product quality and employee morale are difficult to quantify and is often not included in annual report. It is therefore not considered when calculating the company's ratios.
6) Ratios only show problem areas
Ratios are only indicators, i.e. they show areas where performance is lacking. They do not give the reason why performance is lacking neither does them provide any solutions to the problem. It is up to the user to understand the ratios and to find remedies.
7) The growth stage of Debenhams and Next
It should be noted that from this analysis, it seems that the two businesses are at different stage of growth. Debenhams seem to still growing whilst next is nearer to maturity. This disparity is reflected in the results. Therefore users must be careful in analysing the results.
8) Use of fame database
The formula used to calculate the capital employed might be different from Fame Database which is a limitation. Since all the ratios were re-calculated in the same way for the competitor, the results are not biased.
7.1 Possible Solutions to overcome limitations
Over reliance on ratios
Investors should also consider other factors contained in the annual report in tandem with ratio analysis.
Care must be taken when interpreting the ratios. i.e In period of high inflation, ratio analysis of one company over time or a comparative analysis of two companies must be assessed with judgment.
The results were compared to Fame database. But for tricky definition of figures like capital employed and Long-term loan, the figures from the annual report were used and they are well-defined in the calculations.
To conclude, Debenhams is one of the biggest department stores in British retailing industry since 1950. It has more than 240 stores throughout 28 countries. It operates mainly in the retail sector and its major competitor is Next Plc. The Company is listed on the London stock market since 2006. The company's performance over the last five years suggests that it is in a growth stage. The cash flow statement shows that the cash level of Debenhams and Next has both fallen in 2011, as the market conditions deteriorated. Further the Statement of changes in equity indicates that there was no major change in equity capital of Debenhams. The company did not pay dividends in 2010.
Ratio analysis is used to assist in evaluating the performance of Debenhams. Then the results for 2010 and 2011 are compared to Next Plc as a benchmark. Firstly, the profitability ratios show that Debenhams perform worse than its competitors. Though profits have gone up in 2011, the overall profitability of Debenhams has felt. Next generates twice the return on capital employed than Debenhams. This superior performance is backed by the efficiency ratios. The use of DuPont analysis gives a better insight of liquidity and efficiency level of the two companies.
Debenhams effort to reduce debt should be stressed. In 2011, though gearing rose considerably, interest cover improved. This is a result of the company debt restructure process. Furthermore, the investment ratio results are in favour of Next. Though Debenhams and Next has similar dividend pay-out ratio in 2011, no dividend was paid by the former in 2011. But, the increasing P/E ratio indicates that good future prospect for Debenhams. This is reflected in the earnings per share as both companies performance are improving.
From an investor perspective, Next Plc seems a better investment. Indeed, it is more profitable than Debenhams. Also Next Plc is a more liquid company and is generating more cash as reflected in its cash flow statement. Next has a stable dividend policy and high dividend paying company is huge incentive for investors to invest in. The investment ratios suggest that Next shareholders earn more. Other calculated ratios support this idea. Furthermore, Debenhams poor performance is highlighted in gradual fall in its share prices whilst the market index rose over the same period. Therefore the investor would be better off by investing in Next rather than Debenhams.