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One bargain 7% yielder I’d buy today and one I’d avoid

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The retail sector is a tricky place for investors at the moment. In a moment I’ll take a look at a high-yield retailer I would buy, but first I want to consider today’s half-year results from turnaround stock Debenhams (LSE: DEB).

The troubled retailer’s shares were down by 8% at the time of writing, after it revealed a 52% fall in half-year profits and a 51% dividend cut.

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Like-for-like sales fell by 2.2% during the period, although this decline was made worse by snowy weather which forced the closure of nearly 100 stores in March.

You can’t blame the weather

Chief executive Sergio Bucher admits that the UK retailer sector “is undergoing profound change”. He’s hoping that the group can adapt to this new reality by boosting internet sales and redeveloping stores as social destinations, with a focus on fashion, beauty and food and drink.

Mr Bucher may yet succeed. But he’s going to have to spend a lot of cash first.

The group’s turnaround plan, Debenhams Redesigned, is now expected to incur cash costs of £50m, nearly double previous forecasts of about £28m.

Revamping stores, upgrading websites and restructuring warehouses are all necessary, but they cost money. Planned capital expenditure has been cut from £150m to £140m for this year, but that’s still higher than the roughly £125m spent in each of the last two years.

Net debt is expected to reach £300m-£320m by the end of September 2018, up from £275.9m in 2017. The group’s borrowings are starting to look a little high to me, given the weak outlook for profits.

The elephant in the room

However, the biggest problem may be the group’s large and long-leased store estate. The average unexpired lease length is 18 years. This makes it very costly to shut shops, some of which the firm admits are too large.

I think it’s too soon to write off Debenhams. But I believe shareholders face some serious risks.

The stock has now fallen by almost 90% since 2006. And although the shares might look cheap on six times forecast earnings and with an estimated yield of 4%, I believe there could be worse to come. This retailer remains a sell for me.

A 7% yielder I would buy

One stock that’s on my own watch list to consider buying is budget footwear retailer Shoe Zone (LSE: SHOE).

Cheap stores, short leases and low costs mean that the group’s pile-it-high, sell-it-cheap approach generates a lot of spare cash. It’s also easy for management — led by founders Anthony and Charles Smith — to shut underperforming stores without big exit costs.

A cash machine

This firm’s shoes won’t be to everyone’s taste. But it’s a very profitable business. Shoe Zone’s operating margin last year was 6.2%, double Debenhams’ reported figure of 3.1%.

Low costs and the firm’s policy of dealing directly with shoe manufacturers mean that the returns on money invested in this business are high. Return on capital employed (ROCE) was 24% last year, a figure that’s consistent with previous years.

The Leicester-based firm maintains a net cash balance and returns most of its free cash flow to shareholders each year. The shares currently trade on a forecast P/E of 9.1, with a covered forward yield of 7%.

At this level, I believe Shoe Zone stock could be worth buying.

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Roland Head has no position in any of the 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.

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