Shares in multi-channel retailer Debenhams (LSE: DEB) were down by as much as 6% this morning, after the company released a trading update to the market. Should private investors regard this as an excellent opportunity to buy the company’s shares or a signal to stay away?
Drop in sales
Perhaps the most important figure was the slight drop in sales (0.2%) over the last 15 weeks. While disappointing, this is not unexpected given recent similar reports from other retailers. More positively, online sales were up by 7% over the last few months suggesting that the company, like its peers, has recognised the importance of offering a quality experience for shoppers who are unable to visit its stores.
Commenting on the update, outgoing Chief Executive, Michael Sharp, reflected that trading environment
“had been weaker since the new year, particularly in clothing, and our strategy to increase the mix of non-clothing sales has supported our performance against this background, with Health and Beauty sales in particular continuing to show good growth“.
Due to the volatile trading environment, the update goes on to mention that the board would be “keeping costs tight, managing margin and driving cash generation” but still expects this year’s profits to meet forecasts.
Overall, this was a mixed trading update from the company, albeit one that contained little in the way of surprises.
Before today, the most significant news to come from Debenhams was last month’s appointment of ex-Amazon man Sergio Bucher. Given his previous role as vice-president of the online behemoth’s European fashion business, the decision to give him the job is perhaps understandable. Indeed, many of the company’s shareholders may have been heartened by the news following a series of profit warnings and poor results.
While it remains to be see whether this appointment was inspired, I’m more concerned by Chairman Sir Ian Cheshire’s comments that Bucher’s immediate priority is ascertaining the identity of their “core customer“. Given the challenges faced by all retailers at the current time, surely the company already has an idea of the sort of consumer they should be targeting?
Although Sir Ian went on to say that the average shopper at Debenhams would be “much younger than the M&S customer and much more fashion-interested“, this still feels unnervingly vague. As an investor, I’d be worried.
Cheap for a reason?
A forecast price-to-earnings (P/E) ratio of just over 9 for next year and a well-covered yield of just under 5% makes Debenham’s shares look highly tempting at the current time. Nevertheless, I need to be convinced that this company can recover its earnings and offer a better retail experience compared to its high street and online competitors.
Next (LSE: NXT), for example, is trading on a P/E of 12 and yet has a far better track record of earnings growth, operating margins and return on capital employed. Dividends have also grown at a rapid rate over the past five years.
Although its clothing range continues to be less than popular, even Marks & Spencer (LSE: MKS) appears to have better prospects despite the recent slump in its share price, especially given its highly-rated food offering. Its stock now has a P/E of 11 and yields over 6%.
And then there’s Asos (LSE: ASC). Can you imagine a fashion-conscious shopper deleting the online giant’s app and breaking a sweat to rush into one of Debenham’s stores? Neither can I.
If Debenhams has any hope of attracting younger customers, a complete overhaul of its image is required.
The next BHS?
My uncertainty over Debenhams ability to reinvent itself makes me bearish on its shares, regardless of how cheap they appear to be. While there are many differences between this company and the recently-demised BHS, there are also similarities. Both retailers have struggled to grow earnings in the wake of the explosion in online fashion retailing. Both operate in incredibly difficult conditions on the high street. Both are tired, uninspriring brands.
Of course, this is only my opinion. Today's drop may be regarded as a golden opportunity for contrarians to buy a slice of the company. The new CEO (arriving in October) may be able to turn things around and inject Debenhams with some much-needed vitality. However, the sheer scale of the challenge before him suggests to me that the next chapter in this retailer's story could be its very gradual, painful extinction, unless its fortunes dramatically improve.
Research has shown that buying quality companies and reinvesting the dividends they pay is an excellent strategy for building wealth over the long term. While the payouts offered by Debenhams certainly look appealing, I'd encourage investors to look elsewhere. One share they may wish to consider has been identified by the experts at the Motley Fool and detailed in a special FREE report.
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Paul Summers has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.