Debenhams PLC BUY

Debenhams has benefitted from strategic initiatives it has taken in FY2018 Debenhams PLC GBX

in the form of cost reduction, zero final dividend & focus on digitally CMP 6.57
Target Price 10.35
enabled sales. We believe that the company will continue to benefit from
Upside Potential % 58%
these actions in years to come as well and be able to lower its high cost
Avg. Trading Vol. 8.1m
debt. The company is also planning to lower its capex spend for some years
Market Cap (£m) 80.9
and close down its loss making stores, hence increase in profitability & cash
Source: Investing.com, Financial Model
availability. Despite all this, stock was not able to perform well in past years
making Debenhams an attractive opportunity to invest in. DEB vs. LSE
1.40

Going digital leading to lower store operating costs 1.20

1.00
0.80
As the company is focusing on sales through digital mode and has shown 0.60
0.40
YoY growth of 20% in FY18, the company will save huge store maintenance 0.20
-

& operating costs – leading to better margins. Debenhams is also working Nov-17 Jan-18 Mar-18 Apr-18 Jun-18 Aug-18 Sep-18 Nov-18

DEB LSE

on improving its mobile sales experience which drove 12% growth in FY18, Source: Investing.com
targeting to digital sales contribute 30% of total GTV in upcoming years.
The company has 240 stores in total out of which they are planning to close
Shareholding Pattern
50 in next 3-5 years’ time.

No. of Stores - FY18 2.00%

22.81%
Promoters
AMCs
Insurance Co.
15.79% 59.40%
Others

58

165
17 Source: marketscreener.com

Pros. of Investing
UK Stores International Stores Franchise Stores 1. Stable dividend
2. Large Customer Base
Source: Investor’s presentation
3. Adaptability to Technology
Healthy financials even after stores closure
4. Rising RoE
Even with the reduction in stores, we expect revenues & operating profits
to remain at fair level due to its strategic initiatives mainly due to digital
Risks
sales.
1. Lower Profitability margins
Key Financial Data
2. High Debt Burden
(figures in £m, unless stated) 2017A 2018A 2019E 2020E 2021E
GTV 2,954.1 2,900.4 2,838.0 2,767.5 2,685.5
3. Increasing Competition
Revenue 2,335.0 2,277.0 2,235.0 2,175.6 2,112.9
Operating Profit 107.5 43.4 44.0 46.5 57.1
EBITDA 224.2 516.7 162.1 171.0 189.2
Net Income, Adjusted 78.0 27.1 26.5 29.4 39.0
EPS, Adjusted pence 6.35 2.20 2.15 2.38 3.17
Business Introduction: A multi-brand store chain
Debenhams PLC is a British based retailer operating under departmental store
format in UK and Ireland plus franchise stores in other countries. As of FY18, UK
gross transaction value (GTV) represents c.79% of total, with international
contributing 21%. Online represents a significant and growing channel for the
group, providing almost 20% of group-wide GTV in FY18.

UK vs International
3,500

3,000

2,500 21.1%

2,000 19.5%

1,500
78.9%
1,000 80.5%
500

0
GTV (£m) External Revenue (£m)

UK International
Source: Company filings

Increasing Cash Profits and shrinking Debt Burden

With cost reduction and lowering net debt as its target, the company will be
able to save £30 to £50m in costs, hence leaving it with incremental cash profits.
This increased cash profits will be utilized in paying back its debt on books. The
company has also decided to make low capex investments in FY19, therefore
leaving more cash to repay the loan.

Cash from Operations Net Debt

210 350 316.5
162.08 189.23
180
171.04 300
150 262.0
162.1 156.1
120 250
215.9
127.8 131.2
90 200 183.0
60
150
30 28.60
- 100
2018A 2019E 2020E 2021E 2018A 2019E 2020E 2021E

Cash from Operations (£m) Adjusted EBITDA (£m) Net debt (£m)

Source: Company filings, Financial Model Source: Company filings, Financial Model
Improving Profitability ratios
We believe that the company will be able to achieve 7.1% RoE by FY21 against
3.9% in current year. This will be solely due to improved efficiency and cost
reduction that Debenhams is aiming at. Also, its RoCE is expected to reach
above 5% by 2021.

Return on Equity Return on Capital Employed

8.0%
7.1% 6.0% 5.2%
7.0%
5.0%
5.6% 4.1%
6.0% 5.3% 3.8%
4.0%
5.0% 3.0%
3.9% 3.0%
4.0%
2.0%
3.0% 2018A 2019E 2020E 2021E
2018A 2019E 2020E 2021E

Return on Equity Return on Capital Employed

Source: Company filings, Financial Model Source: Company filings, Financial Model

Valuation
We use DCF methodology based on free cash flow projections up to FY21. We
assumed capex to stay c.70m in FY19 as per management guidance and then
gradually increase to support technology expansion i.e. digital sales. We assume
terminal growth rate of 0.25% and a 12% discount rate to obtain fair value of
GBX 10.3 with upside potential of 50%.

Calculation of FCFF 2017A 2018A 2019E 2020E 2021E

EBITDA 224.2 516.7 162.1 171.0 189.2
Tax rate 18.1% 16.0% 17.0% 16.5% 16.8%
EBITDA (1-tax) 183.7 434.2 134.5 142.8 157.5
Add Depreciation tax shelter 21.1 75.6 20.1 20.5 22.1
Net Capex (124.8) (128.9) (69.3) (108.8) (116.2)
Working capital changes 6.6 17.6 (15.0) 6.7 (16.2)
FCFF 86.6 398.5 70.3 61.3 47.3
Terminal Value 403.2
Total Cash Flows 86.6 398.5 70.3 61.3 450.4

Time to receive FCFFs 0.8 1.8 2.8

Present Value of Cash Flows 64.4 50.2 329.3

Cost of Capital (WACC) 12.0%

Growth rate 0.3%
Enterprise Value 443.9
Less: Net debt 316.5
Equity Value 127.4
No. of shares 1,231.9
Value per share (GBX ) 10.3
Financial Statement Exhibits
Consolidated Statement of Profit & Loss 2017A 2018A 2019E 2020E 2021E
Revenue 2,335.0 2,277.0 2,235.0 2,175.6 2,112.9
YoY growth -2.5% -1.8% -2.7% -2.9%

Cost of sales (2,046.1) (2,044.8) (2,011.5) (1,951.5) (1,884.7)

YoY growth -0.1% -1.6% -3.0% -3.4%
% of revenue 87.6% 89.8% 90.0% 89.7% 89.2%

Gross profit 288.9 232.2 223.5 224.1 228.2

Distribution costs (124.5) (133.6) (125.2) (124.7) (119.7)
% of revenue 5.3% 5.9% 5.6% 5.7% 5.7%

Share based compensation (0.5) (0.4) (0.4) (0.4) (0.4)

Administrative expenses (56.4) (54.8) (53.9) (52.4) (50.9)
% of revenue 2.4% 2.4% 2.4% 2.4% 2.4%

Operating Profit/(Loss) 107.5 43.4 44.0 46.5 57.1

Add: Depreciation & Amortisation 116.7 473.3 118.1 124.5 132.1

EBITDA 224.2 516.7 162.1 171.0 189.2

Finance income 0.1 2.3 2.5 1.9 1.9

Finance costs (12.4) (12.5) (14.6) (13.3) (12.2)

PBT 95.2 33.2 31.9 35.2 46.8

Taxation credit/(charge) (17.2) (5.3) (5.4) (5.8) (7.8)
Effective tax rate 18.1% 16.0% 17.0% 16.5% 16.8%

(Loss)/profit before share of associate 78.0 27.9 26.5 29.4 39.0

Share of profit/(loss) in associates - (0.8) - - -

(Loss)/profit before exceptional items 78.0 27.1 26.5 29.4 39.0

Exceptional items (29.2) (488.1) - - -
Net Income, Reported 48.8 (461.0) 26.5 29.4 39.0

Reported EPS (pence) 3.97 (37.42) 2.15 2.38 3.17

Adjusted EPS (pence) 6.35 2.20 2.15 2.38 3.17

NOSH in mn 1,229.0 1,231.9 1,231.9 1,231.9 1,231.9

Consolidated Balance Sheet 2017A 2018A 2019E 2020E 2021E
Assets
Non-current assets
Goodwill 819.5 517.4 517.4 517.4 517.4
Intangible assets 172.4 102.0 106.2 125.6 140.5
Property, plant and equipment 654.9 603.7 550.8 515.7 484.8
Investment in associate - 6.7 6.7 6.7 6.7
Available-for-sale investments 1.2 1.0 1.0 1.0 1.0
Derivative financial instruments 0.5 6.0 6.0 6.0 6.0
Trade and other receivables 19.3 20.4 20.4 20.4 20.4
Retirement benefit surplus 80.9 159.4 159.4 159.4 159.4
Deferred tax assets 15.3 23.2 23.2 23.2 23.2
Total 1,764.0 1,439.8 1,391.0 1,375.3 1,359.4

Current assets
Inventories 374.1 396.0 366.6 373.3 341.3
Trade and other receivables 82.9 81.3 66.1 77.4 61.9
Derivative financial instruments 4.8 8.1 8.1 8.1 8.1
Cash and cash equivalents 40.0 42.7 33.8 33.8 16.0
Total 501.8 528.1 474.6 492.5 427.3

Liabilities
Current liabilities
Bank Overdraft (20.3) (3.8) (3.8) (3.8) (3.8)
Borrowings (96.1) (161.8) (97.8) (51.1) -
Derivative financial instruments (12.0) (4.4) (4.4) (4.4) (4.4)
Trade and other payables (579.6) (615.6) (556.0) (580.7) (517.0)
Current tax liabilities (9.8) (7.3) (7.3) (7.3) (7.3)
Provisions (10.2) (14.1) (14.1) (14.1) (14.1)
Total (728.0) (807.0) (683.4) (661.4) (546.6)

Net current liabilities (226.2) (278.9) (208.8) (168.9) (119.3)

Non-current liabilities
Borrowings (199.5) (198.4) (199.0) (199.6) (200.0)
Derivative financial instruments (5.3) (0.6) (0.6) (0.6) (0.6)
Deferred tax liabilities (54.0) (51.8) (51.8) (51.8) (51.8)
Other non-current liabilities (351.7) (354.4) (354.4) (354.4) (354.4)
Provisions (9.7) (66.3) (66.3) (66.3) (66.3)
Total (620.2) (671.5) (672.1) (672.7) (673.1)

Net assets 917.6 489.4 510.2 533.8 567.0

Equity
Share capital 0.1 0.1 0.1 0.1 0.1
Retained earnings 243.3 (194.5) (174.2) (151.0) (118.1)
Misc Reserves (including share premium account) 674.2 683.8 684.2 684.6 685.0
Total equity 917.6 489.4 510.2 533.8 567.0
Consolidated Cash Flow Statement 2017A 2018A 2019E 2020E 2021E
Cash flows from operating activities
(Loss)/profit before taxation 59.0 (491.5) 31.9 35.2 46.8
Depreciation and amortisation 109.5 115.4 118.1 124.5 132.1
Impairment losses 7.2 357.9 - - -
Loss of disposal and write-off of intangible assets 4.6 78.3 - - -
(Profit)/loss on disposal and write-off of PP&E 1.2 (2.6) - - -
Share-based payment charge 0.5 0.4 0.4 0.4 0.4
Net movements in provisions 5.9 60.5 - - -
Finance income - (2.2) - - -
Finance costs non-cash 1.2 1.4 1.3 1.1 0.8
Pension current service cost 1.5 1.6 - - -
Cash contributions to pension schemes (9.8) (6.2) - - -
Net movement in other long-term receivables (0.1) (1.7) - - -
Net movement in other non-current liabilities (2.8) 2.7 - - -
Others 4.8 (5.1) - - -
Cash from Operations before WC Changes 182.7 108.9 151.7 161.2 180.1

Changes in working capital

(Increase)/decrease in inventories 8.8 (22.1) 29.4 (6.6) 32.0
Decrease/(increase) in trade and other receivables (1.4) 1.3 15.2 (11.3) 15.5
Increase/(decrease) in trade and other payables (0.8) 38.4 (59.6) 24.7 (63.6)

Tax received/(paid) (16.3) 1.3 (5.4) (5.8) (7.8)

Cash generated from operations 173.0 127.8 131.2 162.1 156.1

Cash flows from investing activities

Purchase of property, plant and equipment (72.6) (105.3) (44.7) (65.3) (74.0)
Purchase of intangible assets (52.2) (30.7) (24.6) (43.5) (42.3)
Proceeds from the sale of PP&E - 7.1 - - -
Investment in associate - (7.5) - - -
Finance Income - - -
Available-for-sale investments - - - - -
Derivative financial instruments - - - - -
Net cash used in investing activities (124.8) (136.4) (69.3) (108.8) (116.2)

Cash flows from financing activities

Issue/(Buy back) of Share Capital - - - - -
Share premium etc - - - - -
Borrowings - - (0.7) - -
Drawdown/(repayment) of revolving credit facility (25.0) 66.0 (62.3) (47.2) (51.5)
Dividends paid (42.0) (35.6) (6.2) (6.2) (6.2)
Finance lease payments (1.6) (1.6) (1.7) - -
Others (0.8) (0.8) - - -
Net cash generated from/(used in) financing activities (69.4) 28.0 (70.9) (53.3) (57.7)

Net increase/(decrease) in cash and cash equivalents (21.2) 19.4 (8.9) - (17.8)

Net cash and cash equivalents at beginning 40.8 19.7 38.9 30.0 30.0
Foreign exchange gains on C&CE 0.1 (0.2) - - -
Net cash and cash equivalents at FY end 19.7 38.9 30.0 30.0 12.2