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Table of Contents

Executive summary ....................................................................................................................................... 2

Context external profile ............................................................................................................................. 2

Overview ....................................................................................................................................................... 3

Ratios ............................................................................................................................................................ 4

DuPont Analysis ........................................................................................................................................... 5

The implication of capitalizing the operating leases ..................................................................................... 7

Conclusion .................................................................................................................................................... 9

References ................................................................................................................................................... 10

APPENDIX ................................................................................................................................................. 11

FI4002 Financial Strategy and Investment


Debenhams versus NEXT

Executive summary
The scope of this report is to analyze and compare the performance of Debenhams PLC and NEXT PLC - two companies that compete to each other in the retail industry. The sources for writing this report are mainly web-based secondary data, in particular the annual reports of the two companies. The findings indicate that the financial performances of the companies are much different than what they appear to be at a first glance.

Context external profile


Retail industry is influenced by the uncertainty of the global economy. Consumer spending depreciated because in both Europe, which is the biggest and most important economy for the global commerce, and in the United States taxes were raised and spending was cut in order to reduce the fiscal deficits. The retail industry has changed dramatically over the last years influenced by a customer revolution. Consumers are expecting a great experience when shopping no matter what channel they use. As a result, retailers must comply and deliver this experience. Shopping through mobile devices and online applications are the key drivers of the aforementioned revolution. The UK retailing industry grew during the year 2012 even though the economic conditions were unstable. Key factors such as Olympic Games and Queens Diamond Jubilee were responsible for boosting the industry performance and they managed to offset the sluggish sales at the beginning of the year because of the weather conditions (characterized by a warm autumn and winter season followed by a wet spring and summer). Two companies will be compared in turn, Debenhams PLC and NEXT PLC, which even though they are in different retail sector (department stores and retail apparel respectively), they compete directly in clothing, houseware, footwear and accessories.

Context internal profile

Just like NEXT, Debenhams operates mainly in the UK, but it has a presence in 28 countries where it trades through 239 stores and online in 67 countries. In the UK and Ireland it has 165 stores (NEXT has 500) and 18 more to be opened in the next five years. The total UK trading space is 10.9 million square feet and the new stores will add another 845 thousand. They are positioned well in high streets, town shopping centers and retail parks. Similar to NEXT, more than 70% of Debenhams share are owned by investment management funds such as Schroeder Investment Management (12.4%). They can become a force for a betterr control over the company management decisions. Debenhams rapidly adapted to the new customer behavior and it offers them more availability through multi-channel, for example the visits using mobile channel were 27% (industry average was 15%). The customer experience also improved. Debenhams introduced the chat technology for advising the customers. The company relies on direct procurement which is characteristic to manufacturing and the sourcing hubs are the same with those from where NEXT has its suppliers, but 50% of all the supplies are coming from China/Hong Kong.

Overview
A summary of Debenhams performance over the last two years is given in Table 1 (and a corresponding table is provided in the Appendix for NEXT for comparison). Table 1: Debenhams PLC financial overview (2011-2012)
For the year Sales revenue (m) Profit before interest and tax (m) Profit for the year (m) Dividend for the year(pence) Operating cash flow (m) Capital investment (m) Total debt (m) Employees (people) 9/1/2012 2,230 175 125 3 260 101 412 30,117 % change 0.90% -4.89% 5.93% 10.00% -2.99% 7.45% -0.24% -1.66% 9/3/2011 2,210 184 118 3 268 94 413 30,624

Sales revenue rose by almost 1% in 2012, but after counting for inflation (2.85% on average), the sales figure is actually negative. NEXT on the other hand managed to have a positive real sales growth rate (3.11%), still low but that is because 2012 was a difficult economic year. Profit for the shareholders increased by 5.93% and the company decided to raise the dividend payment by 10%, showing confidence about its future. Unlike NEXT, Debenhams saw a decrease in operating cash flow (-2.99%), probably an indication that the company costs have increased. Capital investment was up 7.4% indicating that Debenhams found opportunities to invest in. In contrast, with a figure of -34.92%, the company either is struggling to find new places to invest, or is waiting for the right economic conditions to do it. The total debt for both companies improved in 2012 and the number of employees decreased in both cases, one of the reasons could be the increase in online shopping. According to this overview, Debenhams does not appear to be overstretched, but a closer look at the company ratios would clarify the things better.

Ratios
Table 2 shows the performance ratios of Debenhams which are almost all worsen from the previous year as opposed to NEXTs (see Table 2 from Appendix). Only the working capital, liquidity and solvency ratios have improved.

Table 2: Debenhams PLC financial ratios


For the year Performance Sales margin Asset turnover Return on Capital Employed Sales per employee Profit per employee Working capital Inventory days Debtor days Trade creditor days Liquidity 9/1/2012 7.85% 1.63 12.83% 74,045 5,811 62.85 3.44 30.86 % change -5.74% -3.61% -9.14% 2.60% -3.29% 2.62% -9.51% -3.73% 9/3/2011 8.33% 1.70 14.12% 72,166 6,008 61.25 3.80 32.05

Current ratio Acid test / Quick ratio Solvency Interest cover Gearing Shareholder's view Return on equity

0.63 0.18 10.29 0.62 18.91%

6.85% 22.39% 28.68% -0.39% 5.77%

0.59 0.14 8.00 0.63 17.88%

Sales margins and asset turnover have fallen by 5.74% and 3.61% respectively which means Debenhams was more efficient in previous year and better at controlling the costs. It also used its assets more effectively in the previous year. In 2012, for every long term tied pound in the company assets, it managed to generate only 1.6 pounds of sales. The competitive pressure in the market made assets more expensive and put pressure on the prices as well. The return on capital employed is 9.14% down from the previous year, but it still has a decent figure of 12.83%, but it pales when compared to NEXTs 60.3%. NEXT is generating more shareholder value through the more efficient use of capital. Even though the liquidity ratios for Debenhams have improved, they are still low even for the retail industry. Having a 0.63 current ratio implies that the company might have some difficulties in meeting short term obligations. The offset is a fairly high operating cash-flow. The quick ratio has risen by 22.39% to 0.18 but this is a very low value and may indicate that the company cannot pay its debts by selling its most liquid assets, if needed. The interest cover ratio has improved by 28.68% thanks to the refinancing of the senior credit facility and reductions in total level of debt and as a result the company does not have any problems in repaying the interest on outstanding debt. Return on equity is 18.91%, a 5.77% increase from the previous year, a reasonable figure after inflation. Return on equity shows how well have the shareholders done by putting their money in the company. NEXT has a staggering 178% return on equity.

DuPont Analysis
The decomposition analysis gives an understanding of how the return on equity has changed and what were the reasons. After conducting the analysis for Debenhams, it can be clearly seen from the resulting graph (Figure 1 below) that the return on equity ratio has grown mainly because of tax cover ratio. Sales margin ratio is pretty much the same along with asset turnover, solvency is slightly bigger but interest cover ratio is responsible for a lower figure in return on equity.
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Figure 1: Debenhams PLC 2012/2011 comparison


Return on Equity 1.40 1.20 1.00 Tax cover 0.80 0.60 0.40 0.20 0.00 2012/2011 Parity Solvency/gearing

Interest cover

Asset turnover

Sales margin

In contrast, Figure 2 shows the decomposition analysis for NEXT. Return on equity dropped by 8.76% from the previous year and the reason was the level of gearing within the company. Figure 2: NEXT PLC 2013/2012 comparison
Return on Equity 1.20 1.00 0.80 Tax cover 0.60 0.40 0.20 0.00 2013/2012 Parity Solvency/gearing

Interest cover

Asset turnover

Sales margin

If Debenhams is compared against the industry median1, it can be seen where the company is doing better than the average. For example, equity multiplier (gearing), sales margin and tax cover are all greater than the industry average, but at the asset turnover chapter, Debenhams is underperforming.

Figure 3: Comparison between Debenhams PLC and the industry median2

Return on equity 1.500 1.000 Equity multiplier 0.500 0.000 Debenhams/Median Parity Tax Asset turnover Sales margin

Interest cover/burden

The implication of capitalizing the operating leases


In order to get an image of the true value of assets and debt in one company, the operating leases from the balance sheet have to be capitalised. Tables 7 and 9 from the Appendix show how considerably the ratios have changed after capitalizing leases for Debenhams and NEXT respectively. Figures 4 and 5 offer a picture of these changes after conducting a decomposition analysis using the new financial ratios for Debenhams and NEXT respectively.
1

The comparison was made using retailers from Standard & Poors 1200 Index to which Debenhams PLC was added.
2

Figure1 from the Appendix of this report shows Next performance against the industry.

Figure 4: Comparison of Debenhams financial ratios before and after capitalizing ratios
ROE 3.00 2.50 2.00 Tax cover 1.50 1.00 0.50 0.00 Cap-lease/Op-lease Parity Gearing

Interest cover

Asset turnover

Sales margin

The equity multiplier and sales margin ratios of both companies have increased considerably, but the asset turnover ratios are worse than before, especially for NEXT which also has a lower return on equity ratio than before. The gearing ratio has also increased because the true value of equity is being underestimated, for example it does not take into account inflation. NEXT is also struggling with the interest cover ratio and this is also why the return on equity is lower.

Figure 5: Comparison between NEXT financial ratios before and after capitalizing ratios
Roe 2.00 1.50 Tax cover 1.00 0.50 0.00 Cap-lease/Op-lease Parity Gearing

Interest cover

Asset turnover

Sales margin

Conclusion
This report concludes that after running a detailed analysis and after comparing it both to the industry and NEXT, Debenhams does not appear to be overstretched and it certainly will not be in difficulty over the next years. However, 2012 was not necessarily the best year for Debenhams, at least compared with the previous one, but the company has a very well defined strategy for the future and a clear focus. The report also showed that, after taking into account the impact over the financial ratios of the capitalizing leases from the balance sheet, Debenhams and NEXT are not very different from one another when it comes to the efficiency in using their assets.

References
Debenhams PLC (2012) - Annual reports and accounts, [online] available from http://ar12.debenhamsplc.com/, (Accessed on 17th of November 2013) Deloitte (2013) Global Powers of retailing 2013, [online], available from http://www.deloitte.com/assets/DcomUnitedKingdom/Local%20Assets/Documents/Industries/Consumer%20Business/uk-cb-globalpowersof-retailing-2013.pdf, (Accessed on 17th of November 2013) Deloitte (2012) The changing face of retail: The store of the future, [online], available from http://www.deloitte.com/assets/DcomUnitedKingdom/Local%20Assets/Documents/Industries/Consumer%20Business/uk-cb-store-ofthe-future-report.pdf, (Accessed on 16th of November 2013) Holmes, G., Sugden, A. and Gee, P.,(2005) - Interpreting company reports and accounts, Ninth Edition, London Prentice Hall. NEXT PLC (2013) - Annual reports and accounts, [online] available from http://www.nextplc.co.uk/~/media/Files/N/Next-PLC/pdfs/latest-news/2013/ar2013.pdf, (Accessed on 17th of November 2013)

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APPENDIX
Table 1: NEXT PLC financial overview (2012-2013)
For the year Sales revenue (m) Profit before interest and tax (m) Profit for the year (m) Dividend for the year(pence) Operating cash flow (m) Capital investment (m) Total debt (m) Employees (people) 1/26/2013 3,548 687 509 105 695 82 747 28,301 % change 3.11% 13.37% 17.01% 16.67% 3.73% -34.92% -0.66% -1.34% 1/28/2012 3,441 606 435 90 670 126 752 28,685

Table 2: NEXT PLC financial ratios


For the year Performance Sales margin Asset turnover Return on Capital Employed Sales per employee Profit per employee Working capital Inventory days Debtor days Trade creditor days Liquidity Current ratio Acid test / Quick ratio Solvency Interest cover Gearing Shareholder's view Return on equity 1/26/2013 18.32% 3.29 60.30% 125,367 22,967 49.85 63.99 28.38 1.48 1.07 23.69 2.61 178.00% % change 5.42% 6.36% 12.12% 4.51% 10.17% -12.00% 1.00% -3.48% -3.64% 3.72% 9.46% -22.55% -8.76% 1/28/2012 17.38% 3.09 53.78% 119,958 20,847 56.7 63.33 29.40 1.54 1.04 21.64 3.37 195.10%

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Table 3: DuPont analysis on Debenhams PLC Return on Equity


Ratios Return on Equity Solvency/gearing Asset turnover Sales margin Interest cover Tax cover 2012 0.189 2.064 1.635 0.064 1.113 0.791 2011 0.179 1.974 1.696 0.064 1.305 0.641

Table 4: DuPont analysis on NEXT PLC Return on Equity


Ratios Return on Equity Solvency/gearing Asset turnover Sales margin Interest cover Tax cover 2013 1.780 3.769 3.291 0.152 1.223 0.774 2012 1.951 4.987 3.094 0.135 1.248 0.753

Figure 1: Comparison between NEXT PLC and the industry median


Return on equity 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00

Equity multiplier

Sales margin

Next/Median Parity

Tax

Asset turnover

Interest cover/burden

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Table 5: Decomposition analysis Debenhams PLC versus Industry Median


Debenhams Return on equity Sales margin Asset turnover Interest cover/burden Tax Equity multiplier 0.19 0.078 1.635 0.905 0.792 2.064 Median 0.148 0.059 2.211 0.905 0.69 1.79

Table 6: Decomposition analysis NEXT PLC versus Industry Median


NEXT Return on equity Sales margin Asset turnover Interest cover/burden Tax Equity multiplier 1.780 0.183 3.292 1.025 0.763 3.772 Median 0.148 0.059 2.211 0.905 0.690 1.790

Table 7: Capitalising leases The impact on Debenhams financial ratios


Ratio impact Operating margin Asset turnover ROCE Interest cover ROE Gearing New 14.43% 0.53 4.13% 2.46 22.75% 4.20 Previous 7.80% 1.63 12.80% 10.3 12.80% 2.61

Table 8: DuPont analysis on Debenhams PLC Return on Equity after capitalizing leases
New ROE Solvency/Gearing Asset turnover Sales margin Interest cover Tax cover 0.228 6.114 0.526 0.129 0.661 0.827 Previous 0.189 2.064 1.635 0.064 1.113 0.791

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Table 9: Capitalising leases The impact on NEXT financial ratios


Ratio impact Operating margin Asset turnover ROCE Interest cover ROE Gearing New 23.21% 1.34 26.01% 9.90 155.55% 4.57 Previous 18.30% 3.29 60.30% 23.7 178.00% 2.61

Table 10: DuPont analysis on NEXT PLC Return on Equity after capitalizing leases
New ROE Solvency/gearing Asset turnover Sales margin Interest cover Tax cover 1.556 6.580 1.343 0.200 1.087 0.807 Previous 1.602 3.769 3.291 0.152 1.223 0.697

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