Institutional initiation

Debenhams
Offering value General retail

15 October 2013
We believe Debenhams’ strategic initiatives will enable the group to
achieve strong medium-term growth via considerably strengthening the Price* 100p
group’s UK proposition, while pursuing capex-light international Valuation 124p
expansion. Additionally, the long-term share buyback plan and, in an Difference 24%
economic recovery scenario, the inherent operating leverage of the store Market cap £1,230m
base could fuel further growth. Despite this, shares are trading at a *As at 8 October 2013
significant discount to the sector, making Debenhams an attractive Net debt (£m) at September 2012 368.7
opportunity in an otherwise expensive sector. Shares in issue 1,234.3m
Free float 86%
Year GTV PBT* EPS* Net debt P/E Yield
end (£m) (£m) (p) (£m) (x) (%) Code DEB
09/12 2,708 158 9.8 369 10.2 3.3
Primary exchange LSE
09/13e 2,780 153 9.7 378 10.3 3.3
Secondary exchange N/A
09/14e 2,858 157 10.2 368 9.8 3.4
09/15e 2,959 168 10.9 337 9.1 3.7 Share price performance
Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items
and share-based payments.

Four pillars of growth underpin numbers

We believe the group’s four key growth channels (UK retail, UK online, international
franchise stores and international online) provide scope for growth even in the
absence of a macroeconomic uplift, and make current consensus numbers
undemanding. We estimate that the strategic initiatives, even using conservative
assumptions, can result in an EBIT uplift of c £30m by 2017, implying an FY12-17 % 1m 3m 12m
CAGR of 3.3%, comparing favourably to consensus forecasts of c 2% EBIT CAGR
Abs (7.0) (11.6) 25.2
in FY12-15. While we acknowledge the five-year growth is likely to be back-end
Rel (local) 1.0 (7.8) 9.7
loaded (due to stores taking time to mature and international online gaining critical
mass), we believe the group’s medium-term growth is well underpinned by the 52-week high/low 150.0p 95.8p
strategic plan and earnings risks are likely to be on the upside. Business description
Debenhams is a leading international, multi-
Additional drivers to provide upside channel brand, which trades out of 236 stores
across 27 countries. It gives its customers a
In addition to the four key pillars, further drivers can provide upside to our numbers.
unique, differentiated and exclusive mix of own
Given that the strategic initiatives do not incorporate any macroeconomic uplift, an brands, international brands and concessions. It
uptick in consumer confidence could have a significant positive impact on the group’s operates via two divisions: UK (81% GTV) and
performance, especially given the operating leverage in its store base. In addition, international (19% GTV).
we believe the group is well positioned to continue buying back shares as cash
generation will further improve after the peak of the capex cycle. We estimate that Next events
continuing the buyback at current levels would result in a cumulative EPS uplift of FY13 results 24 October 2013
6.5% by FY15, with no increase in the group’s financial leverage compared to FY12.
Analysts
Zsolt Mester +44 (0)20 3077 5746
Valuation: At an unwarranted discount Gareth Jones +44 (0)20 3077 5704
Debenhams is currently trading at an over 30% discount compared to the retail institutional@edisongroup.com

sector on an FY14 P/E basis. In our view, historically such a high valuation gap was
deserved due to the group’s capital-intensive nature of expansion and weak
balance sheet. However, we no longer believe such a discount is warranted given
the healthy balance sheet (net debt/EBITDA at 1.4x) and given expansion will
predominantly come from new franchise stores and online sales growth, both of
which are capex-light expansion options. Our DCF and sector-based analysis point
to a valuation of 124p, representing 24% upside to the current share price.
 Investment summary

Company description: A leading multi-channel brand

Debenhams is a leading international, multi-channel brand, which is available in over 90 countries
through stores or online. In the UK, Ireland and Denmark (under the Magasin name) the group
operates under a department store format, while it works under a franchise store system in other
countries. As of FY12, UK gross transaction value (GTV) represents c 81% of the total, with
international contributing 19%. Online represents a significant and growing channel for the group,
providing almost 10% of group-wide GTV in FY12.

Valuation: At an unwarranted discount

We use two different methods to obtain our final valuation: a DCF approach (based on our scoping
estimates up to 2023 and assuming a 10% discount rate and a 2% terminal growth rate) and a
sector-based valuation. Combining the two different approaches yields an average valuation of
124p, providing 24% upside to the current share price.

Financials: Growth initiatives underpin numbers

We expect a c 3% uptick in UK GTV for FY14, predominantly driven by the expected strong growth
in online with some additional contribution from new store openings (two in FY13 and four expected
in FY14). For FY15, we expect similar growth levels as marginally lower online growth is
compensated for by the increased contribution of new UK stores. In international, we forecast a
GTV growth of c 4% for FY14, driven by the rapid expansion of international online, additional
franchise store openings and a further improvement in the trading of Magasin, followed by c 7%
growth in FY15. We expect UK EBIT to grow by over 2% in FY14 as new store openings take time
to mature and further refits are being completed. We expect EBIT growth to rise to c 4% in FY15
due to margin improvement in the online business as well as in new stores. We expect International
EBIT growth of 7% in FY14 and 12% in FY15, due to an increasing bottom-line contribution from
international online, further margin improvement in Magasin and strong profitability from the new
franchise stores. Debenhams has a healthy balance sheet with a net debt position of c £369m as of
year-end FY12 (resulting in net debt/EBITDA of 1.4x). We forecast net debt to peak in FY13 at
£378m due to the significant current capex spending and the share buyback programme. We
expect net debt to reduce in FY14 and FY15, with a forecast net debt of c £337m in FY15, leaving
net debt/EBITDA at 1.2x.

Sensitivities
 Macroeconomic environment: The group’s business is highly sensitive to consumer
confidence and income levels. Therefore, both top- and bottom-line numbers would be
adversely affected by any reduction in disposable incomes both in the UK and globally.
 Competition, brand perception and fashion trends: Fashion trends and brand perception
remain a key risk for Debenhams as sales depend on the continued desirability of its products.
While competition also remains fierce in the fashion retail segment, Debenhams’ brand and
product strategy gives customers a unique and exclusive range of brands, products and
categories under a good-better-best pricing structure.
 Roll-out risk: There is risk associated with the group’s own-store roll-out in the UK as well as
with the international expansion via franchisees, which could lower profitability and hinder
growth.
 Input costs: Cost pressures might arise due to rising raw material prices and increasing
labour, property and other costs.

Debenhams | 15 October 2013 2

  Currency: Given the significant international footprint of Debenhams, there are risks associated
with foreign currency exposure. The group employs currency hedging, but some risks remain.

Company background and description

Debenhams’ origins go back to 1778 when William Clark established a drapers shop in London's
West End. 15 years later, William Debenham joined as a partner and consequently the firm was
renamed Clark & Debenham. With several acquisitions over the next century and offices opened in
South Africa, Australia, Canada and China, the company expanded rapidly and in 1905 the
business has was renamed Debenhams Ltd. In 1928 the group was listed on the stock market for
the first time, marking the end of the involvement of the Debenham family. By 1950, Debenhams
was the largest department store group in the UK, owning 84 companies and 110 stores. In 1985,
Debenhams became part of the Burton Group and during the 13 years of ownership the group has
changed significantly by introducing exclusive products (via, for example, the Designers at
Debenhams initiative) for the first time and by setting up the group’s franchise channel (with the first
franchise site opening in Bahrain in 1997). In 1998, Debenhams was listed on the LSE again, albeit
only for a reasonably short period as the group was acquired by Baroness Retail in 2003 for c
£1.7bn. The group went public once again in 2006 (raising £1.7bn) and is currently part of the FTSE
250 Index. In addition to pursuing the franchise route (and later international online), the group
expanded its international footprint via buying nine stores from Roches in Ireland in 2007 and by
acquiring Magasin du Nord (the leading department store chain in Denmark) in 2009.

Debenhams, as shown by Exhibit 1, positions itself close to the middle of the brand range, with a
slight tilt towards the premium end and an older demographic. Despite the somewhat older
demographics, Debenhams has a diverse customer base with close to 35% of shoppers below the
age of 34, as displayed by Exhibit 2.

Exhibit 1: Debenhams’ market positioning Exhibit 2: Customer profile by age as at FY12

65+ 18-24
14% 12%

55-64
13% 25-34
22%

45-54 35-44
18% 21%
Source: ABA research, Debenhams Source: Debenhams customer profile study

The group has a high focus on product differentiation with c 49% of sales in FY12 coming from core
and designer brands that are exclusive to Debenhams. The group also has a strong offering in the
non-clothing segment, with 51% of sales in FY12 coming from these categories. The group is
particularly strong in the health & beauty segment with a 23.8% market share (source: NPD Group),
compared to a c 4.8% market share in fashion (source: Kantar).

Debenhams operates via two divisions: UK and International. UK incorporates sales and profits
from the UK store-base as well as online performance attributable to the UK. International includes
the contribution of own stores outside the UK (Ireland and Denmark), franchise stores and online
sales ex-UK. As of FY12, UK represented 81% of group GTV and 82% of EBIT, while international
made up the remaining 19% and 18%, respectively.

Debenhams | 15 October 2013 3

 The group’s strategy is based on four pillars: first, an improved focus on UK retail via opening new
stores (two openings in FY13 with four new stores already contracted for each of the next four
years), investing in modernisation (for example the Oxford Street flagship store) and improving the
performance of the un-invested store base. Second, the group aims to enhance the customer
proposition via developing a unique and differentiated offering aided by better in-store execution
and better communication of the proposition. Third, Debenhams seeks to increase the product
choice and availability via a broader multi-channel presence, while offering better customer service
and experience. Finally, there is significant scope to enlarge the group’s international footprint via
franchise stores, the owned store base and the online channel.

Strategic initiatives driving growth

We believe the group’s four key growth channels (UK retail, UK online, international franchise
stores and international online) provide significant scope for growth even in the absence of a
macroeconomic uplift and make current consensus numbers undemanding.

UK retail: Expanding footprint and improving performance

We believe Debenhams has considerable potential to grow its UK retail business further both via
opening new stores and via investing in existing stores to improve performance.

In our view, Debenhams is significantly better positioned to pursue a further roll-out than its main
competitors. There are two main reasons. First, Debenhams has a substantially smaller store base
(at 155 units) than its closest peers: Next reported a store count of 541 as of H113, while M&S has
a store portfolio of 299 units (excluding outlets and food-only stores). We believe this smaller
footprint provides the group with more scope to penetrate new territories within the UK. Second,
despite the strong growth over the last year, Debenhams’ online sales at just below £250m
represented only c 11% of UK GTV in FY12 versus Next at close to 30% and M&S at 13%. This
means that an additional Debenhams store is more likely to win new customers (and have a lower
cannibalisation) than peer stores.

Currently, Debenhams has 16 new stores contracted (four in each of the next four years) in addition
to the two new units opened this year, with management expecting £150m of additional GTV from
these stores. This gives an average GTV per store of c £8.3m for the new stores versus c £12.7m
for the current store base, which we find realistic given that new stores are significantly smaller than
current units (c 47,000sqft vs 70,800sqft), hence management’s target implies similar sales per
square foot assumptions across new and old units. At margins of 6.1% (in line with estimated FY13
divisional margins) this would result in additional EBIT of over £9m (c 5% uplift on FY12 operating
profit). Our positive position on the store roll-out is reinforced by the fact that recent openings have
generated high returns on investment (the 35 stores opened since 2007 generated an average ROI
of c 40%) and future openings fit the prevailing retail trend of moving away from the high street
towards retail park sites (with seven of the 16 openings expected to be in retail parks). In addition to
contracted stores, management is in discussion about a further 25 new stores, which could provide
upside to our current estimate of openings.

While the store roll-out programme is clearly an important pillar of Debenhams’ strategy,
management is also focused on improving the performance of the current store base (which we
estimate to exhibit negative like-for-like sales growth trends currently), especially those deemed to
be underinvested. In 2012 management modernised 18 stores, leaving a further 30 underinvested
stores. The modernisation programme involves adjusting space based on performance, optimising
adjacencies, reclaiming space from back-of-house, investing in the health & beauty department and
upgrading service facilities. The group spent c £32m on this initiative in 2012, resulting in an
average spend of £20-25 per square foot. The modernisation resulted, on average, in a sales uplift

Debenhams | 15 October 2013 4

 of c 6% and 1.5% in the first and the second year respectively following the refit, implying a ROI of c
15%. The programme has continued in 2013 and we believe the number of underinvested stores
has now reduced to 15. We expect the modernisation initiative to conclude by the end of 2014.
Among the stores currently under transformation is the Oxford Street store, which is the group’s
largest store, representing c 4% of sales. The modernisation of the interior is expected to be
completed in time for the 2013 winter peak trading period, while the exterior will be fully revealed by
February 2014. Given the guidance of a c 10% sales disruption for FY13, we believe the new
flagship store will provide some tailwind to like-for-like sales in FY14. Additionally, we believe there
is further scope to increase the sales densities of own-brand products and gain further market
share, particularly in segments where the group is currently underrepresented.

UK online: Scope to beat targets

UK online remains a key driver in management’s multi-channel growth plan and we believe there
are several initiatives that will enable Debenhams to gain further market share in the space.

Debenhams continues to increase choice and availability levels online in order to capture and
convert a higher percentage of online visitors. To achieve this, the group is constantly working on
improving the online product breadth and now has c 110,000 product lines available on the web,
which is c 30% higher than it is for the group’s largest store and c 400% higher compared to the
smallest stores. In addition, Debenhams has introduced a store-based fulfilment model, called
Endless Aisle, which improves product availability by using the stock held on the trading floor and
stock rooms of the group’s 36 biggest stores to fulfil orders for products that are not available in the
group’s distribution centres. This initiative helps capture sales that would have otherwise been lost
(or made at significant discounts) and management estimates a c £16m GTV impact for FY12,
representing over 6% of UK online GTV. In addition to capturing additional sales, Endless Aisle
provides the group with information about demand levels (if the group is out of stock on a product, it
cannot monitor demand effectively) and helps improve stock management.

We also believe improved delivery options will provide a significant uplift to sales. The group had
completed the groundwork by year-end 2012 with the completion of the Sherburn distribution centre
and the transformation that created the Peterborough fulfilment centre, which should allow the
group to implement substantial improvements in its delivery offering. Until September 2013, the
group promised a four-day standard delivery with no next-day option. This was a significantly
weaker proposition than that of competitors: Next offers free next-day delivery to any of its stores
(and also offers a next day delivery to home option for orders made by 10pm the day before), while
ASOS also offers a next-day delivery option (in addition to the four-day standard delivery).
Debenhams is now implementing a next-day delivery option, and there is potential to reduce the
standard delivery to three days, as the vast majority of orders are already delivered within two days.
Given that Next saw a strong uptick in online sales after extending the order deadline for its next-
day delivery to home option, we believe Debenhams’ new initiative could result in a significant uplift
in online sales. The group is also increasing the threshold for free standard delivery to home (from
£30 to £50), which will help the group recover a higher proportion of delivery costs, increase online
basket sizes and raise footfall in stores (via click and collect), driving cross-channel sales. In
addition to the sales uplift via improved delivery options, investment in the distribution system also
enhances collation (which can further drive customer satisfaction) and reduces logistics costs in the
medium term.

Management is targeting £250m of incremental UK online GTV by 2017, which would effectively
double the size of the business line over five years, implying a CAGR of c 15% between FY12 and
FY17. This means there is no material market share gain incorporated in the numbers given that
the online clothing & footwear and health & beauty markets are forecast to grow by a CAGR of 17%
and 13% during the same period, respectively (source: Verdict). We find this undemanding in light
of historic market share gains (with further improvement this year as the group’s market share

Debenhams | 15 October 2013 5

 increased from 2.9% to 3.6% in the 24-week period to 1 September, source: Kantar Worldpanel
Fashion data) and the abovementioned initiatives. However, even using the £250m incremental
GTV estimate and online margins of c 6.3% (marginally ahead of expected FY13 divisional
margins), the group would generate an additional £15.6m of EBIT pre-cannibalisation by FY17.
With management’s estimated cannibalisation rate of 40%, the net EBIT uplift would be c £9.4m,
representing an over 5% increase compared to FY12 group EBIT.

International franchises: Low capital intensity and high roll-out

potential
Management is also targeting significant expansion of the international store base, almost
exclusively via new franchise stores, rather than through own stores. The group’s franchise model
works on a cost-plus basis and partners incur the capex required to build and run the stores. This
provides Debenhams with a capex light and low-risk international expansion opportunity. The group
chooses its franchise partners carefully to make sure they have both the financial resources and the
local market knowledge to make the store a success. In addition, the group has recently changed
its shipping mechanism: previously suppliers shipped their products to Debenhams’ UK facilities,
which then were transported to the franchise stores across the globe, while now suppliers directly
ship products to individual franchise stores. This results in lower shipping costs, frees up
warehouse space, improves working capital and lowers time to market for products.

The group currently has 65 franchise stores and management targets 150 stores by the end of
2017. 25 stores have already been contracted, while management is in discussion about a further
50+ stores, showing a strong pipeline. New franchise stores will almost exclusively be in emerging
market locations, including Asia, the Middle East and Eastern Europe. While reaching 150 stores by
2017 looks ambitious, given that there are over 150 Debenhams stores in the UK alone, we believe
overall the group has scope to increase the number of franchise stores significantly above this
target in the long run.

Management guides to EBITDA of £0.2m per franchise store opened which, given that essentially
all capex is borne by the franchise partner, results is a similar level of contribution on an EBIT level.
Therefore, the 85 new stores that would enable the group to reach a total of 150 would contribute
c £17m of EBIT in the medium term, an almost 10% uplift to FY12 group EBIT.

International online: Rapid growth from a small base

The group also plans to expand the brand internationally via online sales. Currently it is a very small
proposition (few millions of GTV), but management aims to achieve £100m of GTV in the medium
term. Debenhams currently delivers to 66 countries, with a further 30 countries to be introduced
soon. For some of the major markets (Germany, Ireland and Magasin in Denmark) the group
operates a local language website, while other regions are catered for via the group’s English
language website.

We believe that, in the context of Next’s international online expansion, management’s target of
£100m by 2017 is challenging, but not impossible. Next started its international online project in
2009, delivering to c 35 countries. In less than four years (by January 2013) Next’s international
online sales grew to £54m with delivery to 60 international territories, and management expects
revenues of at least £70m by January 2014. While Debenhams’ target of £100m of GTV looks
ambitious we believe the group has some key advantages that could help the group reach this goal.
First, the online retail market is significantly more mature and developed today than it was in 2009,
giving Debenhams an opportunity for more rapid growth. Second, the group already delivers to 66
countries with an additional 30 in the pipeline, while Next had 35 countries in its delivery network in
the first year of the new business line and even now delivery is only offered to 60 countries. This
gives Debenhams a considerably wider reach and a larger market to derive sales from. Third,

Debenhams | 15 October 2013 6

 Debenhams’ international franchises improve the group’s brand recognition and its wide third-party
brand offering helps drive customers to the Debenhams website.

Should the group succeed at reaching the £100m GTV mark by 2017, international online could
make a meaningful contribution to group EBIT. While at such an early stage estimating profitability
is difficult, assuming a 5% margin (which we believe is conservative given that it is substantially
lower than our estimated comparable UK margins) international online would contribute c £5m to
EBIT by 2017. While this assumes no cannibalisation, even assuming a 20% rate (which we find
excessive given that the group does not have any franchise stores in many of the regions where the
group delivers), the business line would contribute c £4m to group operating profit.

Initiatives make consensus numbers undemanding

Overall, the four growth initiatives alone (UK store roll-out, UK online, international franchises and
international online) could enable the group to reach an EBIT of c £215m in the medium term. This
implies an EBIT CAGR FY12-17 of 4.2%, while current consensus numbers (source: Bloomberg,
available up to FY15) forecast operating profits of c £182m by FY15, equivalent to a CAGR FY12-
15 of c 1.5%.

Exhibit 3: Profit progression FY12-17e

250 (7.3)
15.6 5.0
17.0
200 9.2
EBIT £m

150

100 214.5
175.0
50

0
FY12 UK stores International UK online International Cannibalisation FY17
franchises online

Source: Edison Investment Research

Even our base-case scenario (which assumes the old target of 130 franchise stores by 2017 versus
the company’s target of 150 with a back-end loaded opening schedule, uses conservative maturity
assumptions for both own and franchise stores, incorporates further like-for-like deterioration in the
current store base, forecasts UK online sales above the target level and international online at c
£85m) implies a FY12-17 CAGR of 3.3%, leaving FY17 EBIT at £205m. While we acknowledge that
this five-year growth is likely to be back-end loaded (due to stores taking time to mature and
international online gaining critical mass to significantly contribute to the bottom line) and there is
headwind from negative like-for-likes in the UK store base, we believe the group’s medium-term
growth is well underpinned by the strategic plan and earnings risks are likely to be on the upside
even in the absence of any improvement in consumer sentiment.

Additional drivers provide upside potential

We believe that, in addition to the four key pillars, there several other drivers that can provide
upside potential to our numbers. We have already mentioned some of these initiatives (store refits,
choice and availability improvements, sales uptick via improved delivery options, increasing own-
brand sales density), but we think there are two additional drivers that could have a substantial
impact on earnings.

First, given that strategic initiatives do not incorporate any improvement in the macroeconomic
environment, we believe an uplift in consumer confidence could have a significant positive impact
on the group’s performance, especially given the operating leverage within Debenhams’ store base.

Debenhams | 15 October 2013 7

 Consumer confidence, as displayed by Exhibit 4, has been trending upwards in recent months and
is now at its highest since the financial crisis in 2008.

Exhibit 4: Consumer confidence improving

-5
-10
-15
-20
-25
-30
-35
-40
01/09/2008 01/04/2009 01/11/2009 01/06/2010 01/01/2011 01/08/2011 01/03/2012 01/10/2012 01/05/2013

Source: GfK NOP, Bloomberg

We estimate a c 30% drop through on like-for-like top-line growth for the store base, which could
provide margin improvement and earnings uplift should the economic environment improve. While
the operating leverage within the business is considerable, we expect this to reduce over time as
online sales (with a higher variable cost to fixed cost ratio) increase as a proportion of total GTV.

Second, management is committed to a long-term share buyback programme as it sees no

advantage of reducing net debt below 1.0x EBITDA. In FY12 the group bought back c £20m worth
of shares and is on track to complete a buyback of c £40m (over 3% of the group’s market cap) in
FY13. We believe the group is well-positioned to continue buying back shares in the coming years;
with the capex cycle peaking in FY13-14 (at c £135m, falling back to c £100-110m afterwards), cash
generation is likely to pick up significantly beyond FY14 (we forecast net debt/EBITDA to reduce to
1.2x in FY15), providing scope for management to commit to additional buy-backs without
compromising the strength of group’s balance sheet. Should management decide to continue the
buyback programme at c £40m per annum in FY14-15, the cumulative uplift to EPS would be c
6.5%, with no increase in the group’s financial leverage compared to FY12 levels.

Sensitivities

Macroeconomic environment
The business is highly sensitive to consumer confidence and income levels. Therefore, both top-
and bottom-line numbers would be adversely affected by any reduction in disposable incomes both
in the UK and globally. Management monitors market trends closely and has plans in place to help
mitigate any adverse impacts.

Competition, brand perception and fashion trends

Fashion trends and brand perception remain a key risk for Debenhams as sales depend on the
continued desirability of its products. To mitigate this risk, the group follows fashion trends closely to
be able to adjust to changes in consumer preferences rapidly. While competition also remains fierce
in the fashion retail segment, Debenhams’ brand and product strategy gives customers a unique
and exclusive range of brands, products and categories under a good-better-best pricing structure.
In addition, Debenhams is investing additional resources in customer analytics and market
intelligence to ensure that the product offering is compelling and pricing remains competitive.

Roll-out risk
There is risk associated with the group’s own-store roll-out in the UK as well as with the
international expansion via franchisees, which could lower profitability and hinder growth. To

Debenhams | 15 October 2013 8

 mitigate this risk, Debenhams undertakes research of key markets and demographics to identify
potential locations in the UK. In addition, a full investment appraisal is undertaken by a specialist
team, which is responsible for the management of each project. To lower the risk related to
franchises, the group partners experienced retailers possessing strong knowledge of the local
market conditions in addition to financial resources.

Input cost and supply chain

Cost pressures might arise due to rising raw material prices and increasing labour, property and
other costs. Costs are monitored on an ongoing basis across the whole business to identify and,
where possible, mitigate potential cost pressures quickly. In terms of supply chain management,
while focusing on forging strong relationships with all of its suppliers, Debenhams develops multiple
sourcing routes to ensure pricing remains competitive and that demand can be supplied in a timely
manner.

Currency
Given the significant international footprint of Debenhams, there are risks associated with foreign
currency exposure. While the group employs currency hedging, the strategy may not adequately
protect operating results from the impact of exchange rate fluctuations.

Valuation

Sector valuation
As displayed in Exhibit 5, Debenhams is currently trading at an over 30% discount compared to the
retail sector as a whole on an FY14e P/E basis.

Exhibit 5: Peer comparison table

FY14e FY15e
P/E EV/EBITDA EPS growth EBIT growth P/E EV/EBITDA EPS growth EBIT growth
Next 15.5x 10.6x 11.3% 2.8% 14.4x 10.2x 8.0% 5.0%
H&M 23.1x 14.9x 15.2% 15.7% 20.8x 13.4x 11.0% 11.9%
Inditex 27.2x 16.1x 9.6% 6.2% 24.2x 14.3x 12.4% 12.9%
M&S 14.7x 7.5x 2.4% 4.0% 13.1x 7.0x 12.2% 9.4%
FTSE 350 retail index 14.0x 7.7x n/a n/a 12.7x 7.3x n/a n/a
Debenhams 9.8x 5.9x 4.7% 3.0% 9.1x 5.5x 7.2% 5.2%
Discount vs sector (30.2%) (23.8%) (28.1%) (23.7%)
Discount vs Next (36.8%) (44.4%) (36.4%) (45.6%)
Source: Bloomberg, Edison Investment Research

We think historically a high valuation gap was deserved due to the group’s capex-intensive nature
of expansion and its weak balance sheet (with net debt to EBITDA at c 3.7x in FY08). However, we
believe now such a discount is unjustified. The new management team has considerably
strengthened the group’s financial position (with net debt to EBITDA at 1.4x at year-end FY12), and
the vast majority of the group’s expansion is expected to come via new franchise stores and online
sales growth, both of which are significantly more capex-light expansion options than building new
department stores. We believe applying a lower 15% discount is appropriate (reflecting
Debenhams’ below sector-average margins and lower growth profile), which would imply an FY14
P/E of 11.9x and a valuation of 122p. Similarly, the shares are at a significant c 37% discount to
Debenhams’ closest listed competitor Next. While Next arguably deserves a premium compared to
Debenhams due to its superior margins, we believe that, in light of the similar EBIT CAGR14-15 of
the two companies, the nearly 40% discount is excessive.

Debenhams | 15 October 2013 9

 DCF valuation
We also use a DCF methodology (Exhibit 6) based on scoping estimates up to FY23. We assume
capex peaks in FY13-14 at c £135m and then falls to £110m in FY15. We assume a terminal
growth rate of 2% and apply a 10% discount rate to obtain a fair value of 125p.

Exhibit 6: DCF valuation

£m FY13e FY14e FY15e FY16e FY17e FY18e FY19e FY20e FY21e FY22e FY23e TV Total
GTV 2780 2858 2959 3058 3152 3263 3374 3481 3586 3679 3760
PBT 153 157 168 179 192 201 210 220 229 237 245
Tax (32) (33) (35) (37) (39) (41) (43) (45) (47) (49) (50)
NOPAT 121 125 134 142 152 160 167 175 182 188 195
D&A 94 96 98 101 104 108 111 115 119 122 124
Capex (133) (135) (110) (111) (113) (114) (116) (117) (119) (122) (125)
Total 82 85 121 132 144 153 163 173 181 188 194 2476
Discounted 82 78 100 99 98 95 92 89 84 80 75 955 1927
Net cash/(debt) (378)
Enterprise value 1549
Avg. no. of shares 1242
Valuation (p) 125
Source: Edison Investment Research

Averaging the two different methodologies above yields a final valuation of 124p, providing 24%
upside to the current share price.

Financials

Income statement
Exhibit 7: Income statement summary
£m FY11 FY12 FY13e FY14e FY15e
GTV
UK 2181 2205 2276 2335 2401
International 498 503 504 523 558
Total 2679 2708 2780 2858 2959
Y-o-y growth 1.1% 2.7% 2.8% 3.5%
EBIT
UK 156 144 139 142 147
International 28 31 31 33 37
Total 184 175 170 175 185
Y-o-y growth -4.7% -2.7% 3.0% 5.2%
Margin % 6.9% 6.5% 6.1% 6.1% 6.2%
Source: Company data, Edison Investment Research

We expect a c 3% uptick in UK GTV for FY14, predominantly driven by the expected strong growth
in online with some additional contribution from new store openings (two in FY13 and four expected
in FY14). For FY15, we expect similar growth levels as marginally lower online growth is
compensated for by the increased contribution of new UK stores. In international, we forecast a
GTV growth of c 4% for FY14, driven by the rapid expansion of international online, additional
franchise store openings and a further improvement in the trading of Magasin, followed by c 7%
growth in FY15. We expect UK EBIT to grow by over 2% in FY14 as new store openings take time
to mature and further refits are being completed. We expect EBIT growth to rise to c 4% in FY15
due to margin improvement in the online business as well as in new stores. We expect International
EBIT growth of 7% in FY14 and over 12% in FY15, due to an increasing bottom-line contribution
from international online, further margin improvement in Magasin and strong profitability from the
new franchise stores. Overall, we expect an EPS growth of 4.8% and 7.1% in FY14 and FY15,
respectively.

Cash flow
We forecast a net cash outflow in FY13, driven predominantly by peaking capex levels and the
c £40m share buyback programme. As our numbers do not incorporate any further buybacks, we

Debenhams | 15 October 2013 10

 expect cash generation to improve in FY14 and further accelerate in FY15 when the estimated
capex level drops to c £110m from £135m.

Balance sheet
Debenhams has a healthy balance sheet with a net debt position of c £369m as of year-end FY12
(resulting in a net debt/EBITDA of 1.4x). We forecast net debt to peak in FY13 at £378m due to the
significant capex spending and the share buyback programme. We expect net debt reduce in FY14
and FY15, with a forecast net debt of c £337m in FY15, leaving net debt/EBITDA at 1.2x.
Exhibit 8: Financial summary
£m 2011 2012 2013e 2014e 2015e
01-September IFRS IFRS IFRS IFRS IFRS
PROFIT & LOSS
GTV 2,679 2,708 2,780 2,858 2,959
Revenue 2,210 2,230 2,287 2,349 2,429
EBITDA 276 267 264 271 283
Operating Profit (before amort. and except.) 192 184 180 186 195
Intangible Amortisation (9) (9) (10) (11) (11)
Exceptionals 0 0 0 0 0
Other 0 0 0 0 0
Operating Profit 184 175 170 175 185
Net Interest (23) (17) (17) (18) (17)
Profit Before Tax (norm) 160 158 153 157 168
Profit Before Tax (FRS 3) 160 158 153 157 168
Tax (43) (33) (32) (33) (34)
Profit After Tax (norm) 117 125 121 125 134
Profit After Tax (FRS 3) 117 125 121 125 134
Average Number of Shares Outstanding (m) 1,287 1,281 1,241 1,220 1,220
EPS - normalised (p) 9.1 9.8 9.8 10.2 11.0
EPS - normalised and fully diluted (p) 9.1 9.8 9.7 10.2 10.9
EPS - (IFRS) (p) 9.1 9.8 9.8 10.2 11.0
Dividend per share (p) 3.0 3.3 3.3 3.4 3.7
EBITDA Margin (%) 12.5 12.0 11.5 11.6 11.6
Operating Margin (before GW and except.) (%) 8.7 8.3 7.9 7.9 8.0
BALANCE SHEET
Fixed Assets 1,595 1,632 1,655 1,687 1,694
Intangible Assets 858 865 865 865 865
Tangible Assets 635 662 685 717 724
Investments 102 105 105 105 105
Current Assets 424 460 471 502 558
Stocks 321 332 348 364 385
Debtors 72 75 80 85 90
Cash 29 44 35 45 75
Other 1 8 8 8 8
Current Liabilities (716) (727) (753) (773) (794)
Creditors (548) (564) (589) (609) (630)
Short term borrowings (168) (163) (163) (163) (163)
Long Term Liabilities (643) (703) (703) (703) (703)
Long term borrowings (245) (249) (249) (249) (249)
Other long term liabilities (398) (454) (454) (454) (454)
Net Assets 660 661 670 713 755
CASH FLOW
Operating Cash Flow 268 260 265 252 255
Net Interest (20) (14) (17) (18) (17)
Tax (49) (45) (42) (43) (45)
Capex (114) (119) (133) (135) (110)
Acquisitions/disposals 0 0 0 0 0
Financing 0 (20) (39) 0 0
Dividends (13) (39) (41) (42) (45)
Others 0 (12) (2) (4) (8)
Net Cash Flow 73 12 (9) 10 30
Opening net debt/(cash) 517 384 369 378 368
HP finance leases initiated 0 0 0 0 0
Others 61 3 0 0 0
Closing net debt/(cash) 384 369 378 368 337
Source: Company data, Edison Investment Research

Debenhams | 15 October 2013 11

 Contact details GTV by geography

10 Brock Street
Regent’s place 19% 81%
NW1 3FG
www.debenhams.com
International UK

CAGR metrics Profitability metrics Balance sheet metrics Sensitivities evaluation

EPS 12-15e 3.8% ROCE 14e 13.3% Gearing 14e 51.7% Litigation/regulatory 
EPS 13-15e 6.0% Avg ROCE 12-14e 13.7% Interest cover 14e 11.1 Pensions 
EBITDA 12-15e 2.0% ROE 14e 13.6% 6CA/CL 14e 0.6 Currency 
EBITDA 13-15e 3.5% Gross margin 14e 13.8% Stock days 14e 56.5 Stock overhang 
GTV 12-15e 3.0% Operating margin 14e 7.9% Debtor days 14e 13.3 Interest rates 
GTV 13-15e 3.2% Gr mgn / Op mgn 13e 1.8x Creditor days 14e 88.7 Oil/commodity prices 
Management team
Group chief executive: Michael Sharp Chief financial officer: Simon Herrick
Michael Sharp was appointed chief executive in September 2011 having Simon Herrick joined the board of Debenhams in November 2011 and was
previously held the post of deputy chief executive from November 2008 and chief appointed chief financial officer in January 2012. From 2009 to 2011 Mr Herrick
operating officer from May 2006. From 1997 to 2004, Mr Sharp was trading was group finance director and then acting chief executive officer at Northern
director of Debenhams and from January 2004 to May 2006 was chief operating Foods. Before this, he worked for Kesa Electricals from 2004 to 2009, serving as
officer of Debenhams. He previously worked in various capacities within the finance director from 2005 to 2009. Mr Herrick has also held senior roles at
Burton Group, including as managing director of Principles and Racing Green Regus, Hays and Pepsi Cola International.
and Buying and Merchandising Director of Topshop and Topman.
Chairman: Nigel Northridge
Nigel Northridge was appointed chairman of Debenhams on 1 April 2010 having
joined the board on 1 January 2010. He is also chairman of the Nomination
Committee. Mr. Northridge is currently chairman of Paddy Power and a non-
executive director of Inchcape. Previously he was senior independent director of
Aggreko, chief executive of Gallaher Group and a non-executive director of
Thomas Cook Group.
Principal shareholders (%)
Schroders 20.1
Milestone Resources 7.2
Delta Lloyd 5.7
Legal & General 5.2
Blackrock 5.0
Bestinver Gestion 5.0
Majedie Asset Management 4.9

Companies named in this report:

Next, M&S, H&M, Inditex

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