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Why this 7% dividend stock should be a better buy than Debenhams

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The Debenhams (LSE: DEB) share price fell by about 10% on Tuesday, after the firm issued its third profit warning this year. The shares have now fallen by almost 50% since the start of the year.

When I last wrote about Debenhams in April, I warned that there could be worse to come. Unfortunately today’s update confirms that I was right to be worried.

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Sales continued to fall during the third quarter and were 1.6% lower than during the same period last year. Like-for-like sales fell by 1.7%, which was only a slight improvement on the 2.2% LFL decline seen during H1.

Pre-tax profit for the current year is now expected to be £35m-£40m, compared to market forecasts of £50m. Net debt is now expected to be at the top end of previous guidance, at £320m. That’s too high, in my view, but I don’t think it’s the company’s biggest problem.

This is the problem

In April, Sergio Bucher, Debenhams’ newish chief executive said that the group’s website is its biggest and fastest-growing store, with 150m annual visits and annualised sales of nearly £250m. That’s nearly 10% of total group revenue.

This growth continued during the third quarter, when digital sales rose by 16%. Unfortunately, this success highlights the group’s biggest problem — its bricks and mortar stores.

These large-format department stores have an average remaining lease length of 18 years, according to the firm. In my opinion they are too large and too expensive. I suspect some may be unprofitable. But exiting from such long leases will be very expensive.

The company says it’s trialling new-format stores that are delivering higher sales densities and require less discounting. But refitting stores comes at a cost. The firm is now trying to “reduce rollout costs while capturing the majority of expected benefits”.

Keep selling

In my view, Debenhams could still have further to fall. Another dividend cut seems likely to me. I also believe that some kind of financial restructuring may be needed to enable the group to close some stores.

For equity holders, I believe the risks are too high. I’d rate the shares as a sell.

One retailer I would buy

One retail stock I do own is Bonmarche Holdings (LSE: BON). This small-cap firm specialises in affordable womenswear “in a wide range of sizes” for “mature women”.

Sales at this niche retailer have been under pressure and fell by 2.1% to £186m during the year to 1 April. However, tight control on costs helped to lift the group’s underlying pre-tax profit by 27% to £8m.

One bright area is online sales which rose by 34.5% last year, and now account for 9.5% of all sales. This increase helped to offset a 4.5% fall in like-for-like sales in the firm’s stores.

Cash generation also improved, thanks to a reduction in stock levels. Cash generated from operations rose from £9.5m to £10.6m last year. The group ended the year with a net cash balance of £4.3m, and was able to increase the dividend by 8.5% to 7.75p per share.

I’d keep buying

Bonmarche is still something of a turnaround situation. But chief executive Helen Connolly expects to report “further progress for the business” this year.

With the shares trading on 7.3 times forecast earnings and offering a 7% dividend yield, I rate Bonmarche as a buy.

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Roland Head owns shares of Bonmarche. 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.