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This value stock could do serious damage to your wealth

Martin Pettitt. Licence: https://creativecommons.org/licenses/by/2.0/

The explosion in online retail has left many established high street businesses trading on temptingly low valuations. While there may be some bargains to be had, it goes without saying that prospective investors need to tread carefully. 

Treading water

Despite today’s interim results being in “in line with market expectations,” one company that stands out as a value trap more than any other is, in my opinion, Debenhams (LSE: DEB). After all, those expectations weren’t exactly sky high.

In the six months to early March, gross transaction values rose 2.5% to just under £1.68bn with like-for-like growth in the UK increasing 0.5%. Group EBITDA fell 2.5% to £149.1m with performance in the UK impacted by increases in rent and the National Living Wage. Overall profit before tax slumped 6.4% to £87.8m. 

Perhaps the most interesting part of today’s release was the announcement of a new strategy, Debenhams Redesigned. The £679m cap now aims to deliver growth by making itself a destination for “Social Shopping“, based on the idea that the leisure experience — and mobile use — is now an important part of the consumer experience. 

Elsewhere, Debenhams plans to increase the number of staff in customer-facing roles, declutter its stores and replenish stock at a faster rate. One distribution centre and 10 warehousing facilities have been earmarked for closure, with 10 UK stores also likely to be shut over the next five years.  

While CEO Sergio Bucher states that Debenhams prospects are dependent on it delivering “differentiated and distinctive brands, services and experiences,” I think it will struggle to do this in the cut-throat retail environment. This, combined with the fact that additional capex of £20m (on top of the current £130m) will be needed between FY2018 and FY2020 to upgrade its mobile systems, supply chain and store estate makes me suspect that the shares won’t recover any time soon.

Right now, shares in Debenhams change hands for nine times earnings and come with a 6.4% yield, covered almost twice by profits. With shares dipping over 3% in early trading however, the market seems as unconvinced by the new strategy as I am.

Safer bet?

As Debenhams continues to struggle, convenience store operator McColl’s Retail (LSE: MCLS) looks a far better value proposition.

Back in February, the Brentwood-based small-cap reported a 1.9% rise in total revenue to just over £950m over 2016 — the company’s sixth consecutive year of sales growth. Gross margin also rose slightly to 25.1% thanks to a bigger convenience mix, including fresh food and food-to-go (the latter delivering double-digit like-for-like growth).

More recently, total like for like sales were down 1.3% in Q1, giving McColls its fourth consecutive quarter of improvement. The company also reported “no discernible impact on customer behaviour” from the EU referendum.

While these numbers won’t set pulses racing, it’s McColl’s growth strategy — including the acquisition and integration of 298 former Co-op stores — that make me bullish on its shares. If all goes to plan, this could lead to net profits almost doubling by the end of 2018.

Like Debenhams, McColl’s stock trades on an appealing valuation (11.5 times 2017 earnings) and offers a high yield (5.2%). Unlike Debenhams, it’s forecast to post earnings per share growth of 16% in 2017, rising to 30% in 2018. Assuming it can hit these targets, I think the 21% rise in the company’s shares since last April could be just the start of good things to come.

For a smoother journey...

Of course, retailing is a notoriously tough sector. With wage growth slowing and inflation on the up, consumers are becoming even more selective about where they choose to shop.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.