Shares in struggling department store chain Debenhams (LSE: DEB) are up by 30% at the time of writing. The stock’s sudden bounce was triggered by news of a £40m interim financing deal that should keep the group afloat a little longer.
It’s certainly not bad news, but should investors really be piling back into this troubled stock? Let’s take a closer look.
Debenhams has secured the financing facility for 12 months. Interest costs will be fairly high and may rise in April, according to the firm. However, this isn’t intended to be a long-term loan. The new facility is intended to acts as a bridging loan to give the company time to arrange “a broader refinancing and recapitalisation.”
The company has also announced a new sourcing agreement for own-branded goods with Li & Fung, a Hong Kong-based giant in the supply chain sector. This is expected to cut costs and improve product quality in the future. But, in my view, it’s a sideshow compared to the company’s financial difficulties.
Why I’d stay away
Debenham’s biggest problem at the moment is that it has too many large stores on long, expensive leases. In its most recent accounts, the company reported minimum lease payments due of £102m in the next five years, and of £200.5m in the next 10 years.
In addition to this, the department store retailer reported net debt of £286m in early January.
For a company whose underlying operating profit has fallen from £128.6m to £43.4m over the last five years, these figures look unsupportable to me. Refinancing is expected to include agreeing significant rent reductions with landlords. I suspect that some of the company’s debt may also be exchanged for new shares in the business.
To persuade lenders and landlords to agree to a refinancing, shareholders are likely to have to supply fresh cash, or have their stake in the company cut significantly.
In my view, investing ahead of such a deal is highly risky. I’d use today’s price rise as a selling opportunity. I think there’ll be plenty of time to buy cheap shares after the company has refinanced.
This stock could double
FTSE 250 oil and gas producer Premier Oil (LSE: PMO) also has too much debt. But the company completed a refinancing deal in 2017 and is now making steady progress with debt reduction.
The group recently said it expected to report net debt of $2.3bn at the end of 2018, $100m less than its previous guidance of $2.4bn.
Full-year production hit a new record last year, averaging 80,500 barrels of oil equivalent per day (boepd). Although group production is expected to fall to 75,000 boepd this year due to various asset sales, profit margins are expected to improve. Premier expects to be able to continue repaying debt as long as oil prices remain above $45 per barrel in 2019.
I normally avoid investing in companies with high levels of debt, but I do own shares in Premier Oil. I think that the stock’s 2019 forecast price/earnings ratio of 4.2 should rise to a more normal level as debt falls. In my view, the shares could easily double in the next 18 months.
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Roland Head owns shares of Premier Oil. 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.