Whitbread (LSE: WTB) and Debenhams (LSE: DEB) have been under the spotlight in recent days as they updated investors on their trading performances. The former is a lean machine; the latter is a problematic investment case. A banker would argue that both companies, for completely different reasons, may be forced to consider a break-up to shore up their valuations.
Whitbread Shines
Whitbread has managed to deliver value to shareholders with a spectacular performance in the last 12 months. Its stock is up 48% over the period, and 178% since July 2011. Investors have been less willing to pay up for incremental earnings generation in the last eight weeks of trading, however. This points to downside risk.
Whitbread operates two business lines: “hotels and restaurants” — such as Premier Inn and Beefeater Grill — and “Costa”. Hotels and restaurants offer yield, given that they boast a higher pre-tax operating profit than Costa’s coffee shops, but Costa is growing much faster and is increasingly becoming more important for its earnings contribution to the group.
Essentially, Whitbread today is a balanced mix of yield and growth. But if executives found it more difficult to deliver on their promises — which will not be the case if analysts’ forecasts prove accurate – they may opt to go for a break-up, which has been rumoured for ages. A back-of-the-envelope valuation suggests a 20% upside for shareholders under a base-case scenario.
At any rate, this is a profitable business with a balanced capital structure that should be able to continue to perform well for a very long time.
Debenhams Is In Trouble
For most UK retailers, it’s a struggle when it comes to value creation in the current environment. While I believe that certain companies, such as Tesco, could turn their fortunes around under new management, I don’t see why anybody would invest in smaller businesses that don’t offer any competitive advantage vis-à-vis rivals.
Debenhams is one of them. Its stock is down 7% this year, 21% in the last 12 months of trading, and more than 40% since the record high it recorded in November 2012. Debenhams stock is properly priced right now. Moreover, a surge in market volatility, which is possible during the summertime, won’t help it recoup its lost value. Long-term prospects, meanwhile, are not appealing, either.
According to market consensus estimates, a slow growth in revenue will put more pressure on operating margins. As such, very little upside for earnings is expected in future. Debenhams reported a trading update that made for a grim reading last week: among other things, more debt will have an impact on earnings. So, what’s the way out?
Operations overseas aren’t particularly profitable. Perhaps one way to preserve value would be to consider the separation of its domestic business from its small international operations, neither of which has delivered growth in the last three years. That would be the best way to facilitate a takeover.
