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MA International Financial Analysis Financial Analysts Report Dissertation 2013

Kaveh Salehzadeh Nobari 070622373

My gratitude goes to all my lecturers for their support throughtout sound and thoughtful advices. I am also very grateful of my family and my partner for their constant support and encouragement.

the course. Special thanks to Professor Hussain, Dr. Bathia and Dr. Che who always kindly assisted me with my queries and provided me with

Executive Summary
The aim of this report is to analyse the past performance and the future prospects of Debenhams plc in order to provide an investment recommendation on the companys stocks. This project starts with a conducted in the main body of the work. It also provides a Buy or Sell two pages analysts report, which summarizes the detailed analysis bedded in the firms stocks. The main body of the report initiates by and financial performance. Finally, the companys future earnings are forecasted for estimating the intrinsic value of Debenhams equity to cluded by summing up all the information obtained from the analysis and assisting them in making informed investment decisions. determine whether the stock is fairly valued. This work is then con-

recommendation based on this overview and highlights the risks empresenting an outlook on the nature of Debenhams business and later develops into a detailed analysis by evaluating the companys strategy

to provide investors with a clear picture of Debenhams performance

Analysts Report ii 1 2 3 5 7 9 10 11 19 25 28 36 37 38 39 40 45 57 61 63 65 67 68 69 77 85 87 91

1. Basic Factual Information 1.1 Nature of the Business 1.3 Segmental Breakdown 1.4 Basic Statistics 2.1 Introduction 2. Corporate Strategy 2.2 Macro-Environment Analysis 2.3 Industry Analysis and Competitive Environment 2.4 Analysis of Debenhams Business Strategy 2.5 Debenhams Competitive Advantages 2.6 Debenhams Market Choices 3. Financial analysis 3.1 Introduction 3.2 Accounting Adjustments 3.3 Debenhams Common-Size Trend Analysis 3.4 Time - Series Ratio Analysis 3.5 Cross - Sectional Ratio Analysis 3.8 Economic Value Added 4.1 Introduction 3.6 Analysis of the Retail Specific Ratios 1.2 History and Development

3.7 Credit Worthness and Distress Prediction 4. Forecasting and valuation 4.2 Forecasting Earnings 4.3 Equity Valuation Concluding Remarks Bibliography Appendices


Current Price: 108.50p

2010 2,199.90 215.96 202.10 7.5 0.00 Revenue (m) NOPAT (m)

22nd August 2013

Mean Target Price: 144.48p

2011 -0.30 9.1 2012 1.60 9.8 2,209.80 184.72 117.20 2,229.80 195.43 125.30 7.69%

2013(E) 122.41 9.56 -

Recommendation: BUY
2014(E) 125.21 2.20% 9.77 -


Adjusted Net Income (m)

Like for Like Sales (%)

Basic EPS (in pence)

EPS Growth



129.79 3.68% 10.13

Growth of 100
180 160 140 120 100 80 60 40 20 0 2010 2011 2012
Debenhams FTSE 350 FTSE 350 Gen Retail

Investment Highlights: Insignificant growth of 0.9% in revenue in 2012 Strong sales performance in the Danish and The Rest of the World segments Bearish earnings forecast for 2013

Significant increase in the trailing and forward P/E multiples over the past five years

% Return

Debenhams -10.11 -18.94 89.43 3.98

Industry -4.52 -12.83 30.24 30.10

FTSE 350 8.98 -8.22 4.40 2.51


Considerable decline in the companys level of gearing and financing costs Relative and intrinsic valuation of the company, along with positive economic and industry outlooks suggest that the companys stock price is undervalued; hence, a buy recommendation has been given.

2010 2011 2012 YTD

High expected growth in dividend yield, as a result of the recovery of the companys retained earnings

Key Market Data 1.47 Estimated Beta: 94.75 - 108.50 p 52 Week Range: 1.38 bn Market Capitalization: 4.6 m Average Daily Volume: 11.03 Trailing P/E Ratio: 11.35 Forward P/E Ratio: 0.62 P/S Ratio: 4.11 % Dividend Yield: Low Market Short-Selling Activity:

Risks: High Beta implies that Debenhams share prices are volatile Liquidity ratios of less than 1.0 and bearish bankruptcy scores highlight the possibility of financial distress in the case of a market downturn Debenhams non-current assets include high levels of intangibles, which could put the company in a vulnerable position should they require writing down

Business Description
Debenhams is a UK based retailer that trades across 239 stores in 28 countries. The core activity of the company is the sale of fashion clothing, cosmetics, accessories and home products. Debenhams operates as department stores in the UK, Denmark and the Republic of Ireland and as franchise stores in the other regions of the world.

Strategic Outlook
Debenhams main objectives are the modernisation of its UK stores and expanding within the UK market by opening 70 new stores. They believe this will lead to economies of scale and maximize cost efficiency. They further intend to increase investments in multi-channel as a response to increased demands and higher sales growth in e-commerce. Moreover, Debenhams is expanding its brand internationally by opening franchise stores in the emerging markets. It is further attempting to increase awareness of the Debenhams brand by improving its products and own-bought participation, and increasing expenditure on marketing and advertising.

Debenhams plc. Analysts Report 2013

Industry Overview
The retail industry is generally very competitive due to the availability of many close substitutes and lack of product differentiation. Furthermore, the slow industry growth in the UKs retail environment has led to the intense rivalry of the existing players. However, high economies of scale of incumbents, their access to favourable geographical locations and restrictive governmental policies such as the planning regulations of 1996, all to some extent act as barriers to entry.

Opportunities The good performance of the Danish and the rest of the world segments of the company indicates that Debenhams has the opportunity to invest more in the international markets. Furthermore, the companys internet sales have been more profitable than its street sales, which suggest that more emphasize should be put on this line of the business. Threats Due to the cyclical nature of the retail industry, the company is vulnerable to economic downturns. Furthermore, Debenhams is susceptible to adverse weather conditions, which have historically resulted in losses or decreases in its sales. The slow industry growth has further increased Debenhams competition with other retailers. Finally, if the Chinese governments proposed policy for increasing minimum wages is enacted, Debenhams costs of sales would increase considerably.

Share Price Performance

Debenhams share price movement in the years 2010 to 2012 remained relatively stable and followed a similar trend to that of the companys industry peers and the overall market. However, the development of an upward trend in May 2012, led to the major out-performance of the FTSE 350 and the FTSE 350 General Retail indices, doubled the share prices and resulted in the significant increase of the companys price multiples. In 2013, both Debenhams and the UK retail industry have outperformed the FTSE 350 Index. The anticipated industry growth based on positive economic outlooks along with the desirable UK climate in the summer of 2013, suggests that the upward trend of Debenhams share prices may continue in the foreseeable future.


SWOT Analysis

Strengths In the UK, Debenhams has a leading position in health and beauty, top four market share in menswear and womenswear and it is the 11th largest online retailer. Debenhams strong and long-lasting relationship with its suppliers has enabled it to enjoy high levels of flexibility and allows the company to negotiate favourable terms with its suppliers. Moreover, Debenhams has been able to sustain its brand value and quality reputation over the years and has offered a differentiated range of products and a strong portfolio of brands to its customers. Weaknesses Debenhams has defined its target market too broadly, which has prevented it from positioning its products more effectively. Furthermore, the operating profit margin of the company has been following a downward trend in the recent years. Research has further shown that the internal architecture of the company is weak, despite the companys many efforts in improving the employees satisfaction. Finally, there have been concerns raised by Debenhams internet customers regarding the companys poor customer service.

The forecast result obtained in this report suggests that Debenhams earnings in 2013 would drop by -2.45% to 9.56 pence per share, which is a significant fall in comparison with the growth in previous years. This figure was obtained by averaging the outcomes of many different forecasting methodologies. Coincidentally, this estimate is very close to that reported by Reuters, which is ranged from 8.78p to 10.09p with an average of 9.68 pence per share. The forecasts for 2014 and 2015 on the other hand show signs of positive growth. It is important to note that many forecasting methods use statistical models in estimating future earnings and are not adequate for analysing the companys future performance.


The relative valuation of Debenhams has indicated that the trailing and forward P/E multiples are significantly above its historical average. Furthermore all price multiples of Debenhams are considerably below the industry average and at a premium. The intrinsic value of Debenhams stock was calculated by the means of discounting the expected future dividends and the expected future abnormal returns of the company. Both models should theoretically give the same results, however, due to the assumptions made on the ROE in the residual income valuation, the results were different. According to the dividend discount model the target price of Debenhams is 119.40 pence, which is at the upper range of the Reuters analysts forecast. The residual income model, however, gave a target value of 169.56 pence, which is out of the analysts range. The target price in this report was calculated by taking the average of the two models, which gave the value of 144.48 pence per share.
Debenhams plc. Analysts Report 2013 ii

Debenhams plc. Analysts Report 2013

1.1 Nature of the Business


Debenhams plc is a multination-

al retail chain of British origin, which trades under the symbol DEB in the London Stock Exchange and is a constituent of the FTSE 250 Index.

The Debenhams brand is inter-

nationally recognized and is traded out of 239 stores, across 28 countries. The retail chains are in the form of department stores in the United Kingdom, Ireland and Denmark, with 68 stores

operating as franchises in other over 29,000 individuals in fullat Debenhams.

countries. There are currently time and part-time employment Debenhams offers a wide variety of products such as fashion clothing, shoes, accessories,

home and furniture and a range of other goods. It currently leads the UK market in health & beauty and home & furniture, and in Menswear, womenswear and childrenswear.

has respectable market shares

Debenhams plc. Analysts Report 2013 2

1.2 History and Development

1778 1818: The Establishment of Clark & Debenham In 1778, William Clark estab-

1851: Debenham & Freebody In 1851, Clement Freebody invested in the company and as a result the name of the business

1905 1928: From Debenhams Ltd to Debenhams PLC The acquisitions that took place continued into the 20th century in the late 19th century and

lished a whole sale clothes store

at 44 Wigmore Street in the West End region of London, in which he sold expensive fabrics, bonnets, gloves and parasols. The shop was later named Clark & Debenham following the invest-

was changed to Debenham & Freebody. The business was then further expanded to a wholesale

resulted in the incorporation

of Debenhams Ltd in 1905. In with Marshall & Snellgrove and

business in which items such a

1919, Debenhams Ltd merged in 1920 it acquired Harvey Nichwent public. (Debenhams, 2013)

ment of William Debenham in

cloth were sold to other retailers. was involved in the acquisition of many businesses of retail, wholesale and manufacturing

the business in the year 1813. In 1818, a replica of the store on the Wigmore Street was opened in Cheltenham. (Debenhams, 2013)

In the 19th century the business

ols. By the year 1928 the business

and it opened offices in Australia, (Debenhams, 2013)

Canada, China, and South Africa.

Figure 1. William Debenham (Source: Debenhams, n.d.)

Figure 2. Debenham & Freebody (Source: The Courtauld Gallery, n.d.)

Debenhams plc. Analysts Report 2013

1950 1977: The Expansion of UKs Largest Department Store The fast growth of Debenhams

1985 1998: Debenhams as a Part of the Burton Group From the years 1985 to 1998, Debenhams PLC was a part of a multinational British retail store called the Burton Group (currently known as Arcadia PLC). During this time the business strategy of Debenhams was altered and was introduced by Debenhams. more exclusive merchandise Furthermore, there was a signif-

1998 Present: Debenhams in the Past Decade Upon demerging from the Burton

led it into becoming the largest department store in the UK by the year 1950. By this year the company was the owner of 84 companies and 110 stores and it further continued to grow un-

Group, Debenhams got listed in

the London Stock Exchange. In 2003, following the acquisition of Debenhams by Baroness Retail

Ltd, the company was removed from the LSE, but was later returned in May 2006.

til 1966, when for the first time to the market. In 1977, all the were rebranded from their original names with the exception of 2013)

central buying was introduced stores acquired by Debenhams

icant rise in the number of the Debenhams stores. Finally, in 1997, Debenhams first franchise country of Bahrain. (Debenhams, 2013)

In 2007, Debenhams purchased nine stores in the republic of Irefurther acquisition of Magasin du Nord , a leading department store ber of 2009. (Debenhams, 2013) land, which was followed by the

Brown of Chester. (Debenhams,

opened in the Middle Eastern

chain in Denmark. in the Novem-

Figure 3. Debenhams in Bahrain (Source: Retail Week, 2012)

Debenhams plc. Analysts Report 2013 4

1.3 Segmental Breakdown

Lines of Business Debenhams has identified retail as its only reportable segment. wide range of products within this marized in the graphs below. However, the company offers a segment, which have been sumThe products sold by Debenhams The largest percentage of the brands includes

Geographical Segments Debenhams segmental reports have only been available from the August of 2009, when the compafollowing the acquisition of the portfolio in 2009. Hence, the segducted for the past three years. ny adopted the IFRS 81. This was

companys annual sales in their own-bought Health and Beauty and womens-

wear. On the other hand, Food Ser& Furniture only take up about 4% of the total own bought sales.

vices, Sports & Leisure and Home

Danish chain Magasin Du Nord,

which was added to Debenhams mental analysis can only be conFigure 7 indicates that the majority of the sales has been generated by the UK segment. The underly-

constitutes their own brands, (cataccount for about half their sales),

egorized as core and designer that international brands and their what equal shares of total sales.

concession brands, with some-

Figure 4. Sales by Brands (2012)

Figure 5. Own Bought Sales by Category (2012) 1% 3% 0%

12% 23% 14% Own bought core brands Own bought designer brands Own bought international brands Concessions / Consignments
1 IFRS 8 requires the disclosure of operating segments.

18% 14% 6% 10%

Debenhams plc. Analysts Report 2013

Womendwear Menswear Childrenswear Lingerie Accessories Health & Beauty Home & Furniture Sport & Leisure Food Services

Figure 6. Debenhams Stores Concentration

ing reason is that Debenhams has only recently initiated its expansion within the international markets, therefore, the companys main development took place in the United Kingdom. As shown in figure 8, the performance of the UK segment is of high importance as it is responsible for over 80% of the total revenue earned by the company annually. Furthermore, table 1 illustrates that over 95% sets are held by the UK segment. Figure 7. Segmental Revenue
2000 1800 1600 1400 1200 1000 800 600 400 200 0 m

Table 1. Segmental Non-Current Assets

(in m) 2010
1,469.60 40.80 29.10 1,539.50 N/A

1,436.00 39.20 35.20 1,511.00 0.60

1,476.10 32.10 33.30 1,545.80 4.30

of Debenhams Non-current as-

UK Republic of Ireland Denmark Rest of the World TOTAL

Figure 8. Segmental Share of the Total Revenue (2012)




Rest of the World


Republic of Ireland



Table 2. Segmental Revenue

Country of Stores

UK Republic of Ireland Denmark Rest of the World TOTAL

154 11 6 68 239

Revenue, m 1,799.80 150.40 103.60 2,119.90 66.10


Change, % +6.47 -7.10 N/A +4.42

Revenue, m 1,851.80 144.10 136.90 2,209.80 77.00


Change, % +2.89 +32.14 +16.49 +4.24 -4.19

Revenue, m 1,860.30 136.50 142.70 2,229.80 90.30


Change, % +0.46 +17.27 +0.91 +4.24 -5.27


Debenhams plc. Analysts Report 2013 6

1.4 Basic Statistics

Size The market Capitalisation is a size. It is calculated by multiplystanding with the market value of current market capitalisation

Financial Performance The analysis of Debenhams sales in the past five years shows that However, from 2011 this growth revenue increased each year. slowed down and in 2012 the an indication that the companys

good indication of a companys ing the number of shares outthe companys stock. Debenhams of 1.3bn places it at the lower

financing costs have decreased by a large margin in the past five years. As shown in Figure 13, the EPS

companys sales grew by only 0.9%. Furthermore, The companys operating profit has not changed in these years, while

trend has been somewhat vol-

end of the FTSE 250 index. As it ket capitalisation of Debenhams has increased significantly in

atile. It had a peak of 10 pence,

can be seen in graph 9, the mar-

the net profit of the company

which was followed by a rather

increased significantly. This is

massive decline, however it was later increased over a two year period.

the recent years from only about The companys total assets have increased considerably in the recent years while its total liabilities have decreased by about increase in the companys net assets by over 500%.

400m in 2008 to 1.2bn in 2012.

Figure 9. Market Capitalisation


1,400 1,200 1,000 800 600 400 200

20%. This has led to a major





Table 3. Assets and Liabilities (in m) 30 Aug 2008 29 Aug 2009 1,984.30 1,859.00 125.30 383.65 2,135.80 1,710.50 425.30 690.12 28 Aug 2010 03 Sept 2011 2,087.30 1,583.90 503.40 690.66 2,018.20 1,358.60 659.60 648.52 1 Sept 2012 2,091.20 1,430.20 661.00 1,199.04

Total Assets Total Liabilities Net Assets Market Capitalisation

Debenhams plc. Analysts Report 2013


Figure 10. Trend of the Balance Sheet Indicators

2,500 2,000 1,500 1,000 500 0 m

Figure 11. Revenue Trend


Total Assets Total Liabilities Net Assets

2,500 2,000 1,500 1,000 500 0




2011 2011





Figure 12. EBIT and Net Profit Trends

200 180 160 140 120 100 80 60 40 20 0 m 12 10 8 6 4 2 0


Figure 13. Debenhams EPS Trend


Operating Profit Net Profit

2008 2009 2010 2011 2012

Earnings per Share

2008 2009 2010 2012

Table 4. Key Financial Indicators (in m) 30 Aug 2008 29 Aug 2009 1,839.20 176.10 77.10 9.00 1,915.60 182.20 95.10 10.00 28 Aug 2010 03 Sept 2011 2,119.90 189.70 97.00 7.50 2,209.80 183.70 117.20 9.10 1 Sept 2012 2,229.80 175.00 125.30 9.80

Revenue Operating Profit Net Profit Earnings per Share (In Pence)

Debenhams plc. Analysts Report 2013 8


Debenhams plc. Analysts Report 2013

2.1 Introduction

Corporate strategy is a managepanies and enterprises around

ment practice utilized by comthe globe with the aim of im-

of the company (McDonald & Christopher, 2003). The method by which Debenhams strategy is analysed, is the Top-down approach. The reason cyclical nature of the retail industry. The retail and wholesaling


proving the firms competitive strategy and adding value to the business (Porter, 1980). Porter (1980) identified activities such as industry analysis, competitor analysis and strategic positioning as the major disciplines of formulated the competitive strat-

for this choice lies behind the

sectors have particularly been cycles in the past. They were hit

competitive strategy. He further egy of a company by identifying the limits of what a company can successfully accomplish.

extremely sensitive to economic hard during financial recessions and recovered as the economy down analysis enables looking at picked up (OFT, 1997). The topthe big picture before analysing individual company.

the key factors, which determine

When evaluating Debenhams strategy, it is important to consider both micro-environmental and macro-environmental factors that affect its performance. Micro-environmental factors are

the specific characteristics of the

those, such as the relationship of the company with its customers, suppliers, petitors, media, and employees. Macro-environmental factors on the other hand, attempt to analyse the effects that political, economic, regulatory, and industrial changes have on the performance shareholders, com-

(Source: Debenhams plc. Analysts Report 2013 10

Figure 14. Top-Down Analysis

2.2 Macro-Environment Analysis

A retailers ability in generating

long-run profits is heavily influenced by the macro-environmental conditions. Therefore, analysing Debenhams strategy requires the examination of the external environment surrounding the

Political and Legal Interventions Changes in Regulation Any intervention in retailing by the UK government in the last few decades has been with the aim of de-regulation and the objective of ateffect (BBC, 2011). According to the

UK governments website (2013), many regulations on UK businesses are ineffective and unnecessary and complying with them costs

company and the forces that have performance. For

direct or indirect impacts on its this analysis, the PESTLE meth-


taining a free market economy. Some examples are removing the restrictions on the stores opening hours in the year 1994 and the amendment the book trade in 1995 (Burt et al, 2010). of the resale price maintenance in

businesses time and money, and can restrict growth. As a result, in 2013 the effectiveness of regulations are being assessed and the government is running a one in, two out rule examination of the new regulations, for new business regulations. The which were put into effect in the April of 2013 (such as the extension of unpaid parental leave from 13 to 18 weeks), indicates that these new laws do not have any material impact on the performance of the UK retailers.

odology has been used, which social, technological, legal and the companys performance.

examines the political, economic, environmental factors that affect

In 2011, the governments Plan for Growth policy aiming to stimulate the economy by reducing bureaucracy and promoting the growth of small businesses was put into

11 Debenhams plc. Analysts Report 2013

Impact on the Economy In March 2013, upon the announcement of the 0.6% UK growth forecast, the revised budget plan was delivered to the UK parliament

Political Stability With regards to political stability UKs domestic and foreign currency government bond ratings from Aaa to Aa1. This resulted political risk premium. Moodys

in 2013, the world map in the next page reveals that Britain, Republic of Ireland and Denmark

(BBC, 2013). According to the 2013 budget, capital spending will be increased by 3bn a year from

have very low political risks, while China on the other hand is shown to have a relatively high

in the increase of the countrys (2013) justified this downgrade by highlighting the risks that may arise from the execution of UKs um means that when calculating

2015 to 2016 by cutting current

spending (UK Government, 2013). growth and help UK businesses

risk. The political risks in China range from nationalisation of industries, through asset confiscation and onto contract repudi-

Furthermore, in order to promote in creating jobs, the main rate of This decrease in corporate taxes would result in the higher profitability of the UK retailers such as Debenhams.

fiscal plans. A higher risk premithe cost of equity of the company, a Country Risk Premium needs to be added to the equity risk premium as follows:

corporation tax is reduced to 20%.

ation with respect to government entities (China Risk Management, n.d.). One of the major political risks, which affect the effect on Debenhams is the battle between the local and central

suppliers and may have adverse


A possible risk for Debenhams is According to BBC (2013), China has approved a plan that increas-

the increase in the supplier costs.

governments, meaning that often rules to follow.

the suppliers do not know which In 2013, the credit rating agency

es the Chinese minimum wage to 40% of average urban salaries by 2015. If this plan is put into effect, will in turn increase Debenhams costs of goods.

of Moodys (2013) downgraded

the higher Chinese labour costs

Debenhams plc. Analysts Report 2013 12

Political Risk 2013

Risk and opportunity hotspots in key growth markets
Principal Political Risk Insurance Coverages
Coverage Protects Against: Type
In addition to assessing short term, dynamic risks, the PRA 2013 also incorporates the Political Risk (Structural) Index, which assesses long term political risks, such as infrastructure readiness and societal resilience, which contribute to a countrys long term growth environment. By analysing both dynamic and structural risks, the PRA 2013 thus enables businesses and investors to make an assessment of their exposure to a comprehensive range of political risks and take steps to mitigate them.
For more information see or contact

The Political Risk (Dynamic) Index assesses risks that have the potential to undergo change, and in particular to deteriorate, rapidly due to direct government action, business activities or due to action by sub-state or other politically-motivated groups. It is comprised of 29 political risk indices under the four themes of governance framework, political violence, business and macroeconomic risk and societal forced regime change risk. The Political Risk (Dynamic) Index is part of Maplecrofts Political Risk Atlas (PRA) 2013.

Arctic Ocean

Regime Stability Index: 6.37

Extreme Risk

Higher localised intensity





Political Risk (Dynamic)

13 Debenhams plc. Analysts Report 2013

Macroeconomic Environment Index: 6.98



Resource Nationalism Index: 5.35

U. S. A.

Atlantic Ocean





Host Government acts interfering with fundamental ownership rights of the investors interest in a Foreign Expropriation Enterprise, including confiscation, nationalisation, selective discrimination and creeping expropriation. Physical damage loss to assets located Political overseas caused by political violence (war, civil war, revolution, insurrection, Violence strikes, riots, sabotage and terrorism). Abandonment of a Foreign Enterprise as a result of advice by the direct investors Forced home government to evacuate key Abandonment expat personnel from the Host Country because of Political Violence. Loss of business income by the Insured resulting as a consequence from Business business operations in the Host Country Interruption having been interrupted by Political Violence or Expropriation. Delay or inability of a Foreign Enterprise to exchange local currency into hard Currency currency (inconvertibility) or to repatriate Restrictions hard currency funds outside the Host Country (Non-transfer). Regime Stability Index: 4.60



Human Security Risk Index: 2.09














Political Violence SOMALIA Index: 3.10


Viet Nam

Political Risk Legend

Societal Force Regime Change Index: 3.83





Remittances Risk Index: 5.02

India Tanzania
Political Violence Index: 7.12

Extreme Risk >0.00 1.25 >1.25 2.50

High Risk >2.50 3.75 >3.75 5.00 Low Risk >7.50 8.75 >8.75 10.00

Peru Brazil


Conflict and Political Violence Index: 2.12

Regime Stability Index: 7.58 Business and Macroeconomics Index: 5.48




Medium Risk >5.00 6.25 >6.25 7.50 NoSOLOMON dataISLANDS





Resource Nationalism Index: 3.86

Increasing Risk No Improvement Decreasing Risk



Indian Ocean

Conflict and political violence




maplecroft Conflict and Political Violence Intensity Index: Colombia


Corruption Risk Index: 6.72

Political Risk (Dynamic) Index: Top 20 highest risk

Rank Country Rating

Political Risk (Dynamic) Index: Top 20 Growth Markets

Country Rank Rating














Resource Nationalism Index: 4.06






Political Risk (Dynamic) Index 2009-2013: BRICs




Conflict and political violence








maplecroft Conflict and Political Violence Intensity FALKLAND Index: Turkey ISLANDS












Conflict and Political Violence Index: 0.74




Terrorism Risk Index: 1.50



Conflict and Political Violence Intensity Index 2013


Conflict and Political Violence Index 2013

Localised Terrorism Intensity Index 2013

! \

Extreme Other major cities and towns

National capital


China India Russia


Administrative boundary

High Risk Localised Terrorism Intensity Index 2013 High Medium Risk

Low Risk




400 km

Izmir Diyarbakir

Data source: Maplecroft, 2012





Maplecroft, 2012 Extreme



National capital

Other major cities and towns


Data source: Maplecroft, 2012; WITS-NCTC, 2012







1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Somalia DR Congo Sudan Afghanistan Myanmar Libya Iraq C.A.R Syria Yemen South Sudan Pakistan North Korea Cte dIvoire Zimbabwe Nigeria Russia Chad Burundi Iran

Extreme Extreme Extreme Extreme Extreme Extreme Extreme Extreme Extreme Extreme Extreme Extreme High High High High High High High High

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

China India Indonesia Viet NEW ZEALANDNam Bangladesh Brazil Philippines Nigeria South Korea Malaysia Russia Tanzania Singapore Hong Kong (China) Peru Thailand Egypt Colombia Turkey Uzbekistan

61 35 60 70 33 109 29 16 161 123 17 83 180 177 97 63 27 49 71 43

High High High Medium High Medium High High Low Medium High Medium Low Low Medium High High High Medium High
Maplecroft 2013

Maplecroft 2013 | The Towers, St Stephens Road, Bath BA1 5JZ, United Kingdom | t: +44 (0) 1225 420 000 | |


Conflict and Political Violence Index 2013

Localised Terrorism Intensity Index 2013



! \ \

National capital Other major cities and towns Administrative boundary

Higher localised intensity


Extreme Risk High Risk




Medium Risk Low Risk EGYPT


Data source: Maplecroft, 2012


400 km

Maplecroft, 2012

(Source: Marsh, 2013)

Economic Environment Global, EU and The British Economic Growth The UK economy witnessed a

A survey conducted by PMI

indicated that in the past few

to the 0.7% GDP growth of the These figures all indicate that

0.3% growth in GDP in the first quarter of 2013 and it was followed by a 0.6% growth in the second quarter. The graph below shows UKs historic GDP trends and the future prospects for the economy as forecasted by PwC (2013). The most likely estimat-

months all the major UK sectors retail sectors growth in sales in Debenhams 2013). prospects

German economy (BBC, 2013). the prospects for the Irish segment of Debenhams, which had experienced negative growth in sales in the past few years may be provements of the sales growth.

had shown signs of recovery. The May 2013 has further improved (PwC,

positive, as there are hopes of im-

In the second quarter of 2013, the Eurozone grew by 0.3% after 18 months of economic contraction, which led into its emergence

ed scenario is rather positive, with an expected growth of 1% in 2013, and a growth of 2% in 2014.

from recession. This growth was

ahead of the forecasts mainly due

Figure 15. GDP Growth Scenarios

Debenhams plc. Analysts Report 2013 14

The forecasts of the UK consumer GDP, but somewhat weaker due

spending are similar to that of to the negative growth in the real


(2013), the global GDP in the first when this figure at the same time rate.




quarter of 2013 grew by only 2.1%, in 2012 was at a reasonable 3.1%

earnings. Positive real growths onwards.

are forecasted to occur from 2015

Figure 16. EU GDP Growth (Source: BBC, 2013)

Figure 17. World GDP (Source: The Economist, 2013)

15 Debenhams plc. Analysts Report 2013

Inflation The consumer price index has been rather unstable in the past few months and PwCs gested that the inflation could

no positive growth is expected

until the years 2015 2017. On ployment growth has had an

tative Easing (QE) performed by the government. However, it is believed that the investors attitude towards risk will return to its normal level and it is estimated that by 2025 the 10 year gilt rates will be around 4 5.5%. Housing Prices

the positive side, the UK emupward trend and the improved employment rates could increase the household income. Furtherspending cuts, the non-employ-

(2013) economic outlook suggo as high as 3% over the sum mer period, which is above the target rate of 2.7%. The figures cate the inflation rate had been

more, following the government ment incomes are also expected (PwC, 2013). All this may result in increased growth in the retail fit Debenhams.

released in August 2013 indiat a moderate 2.8%, which is close to that of the target (BBC, 2013). Based on the estimations, the inflation rate in 2014 is expected to be above the target of 2.4% (PwC, 2013). High levels of inflation mean that

to continue growing until 2016

The house prices are expected to recover based on figure 18. casted to reach their peak in real House prices have been foreterms (i.e. adjusted for inflation)

sector, which in turn would beneInterest Rates

by 2021. This would, however, they will have to purchase new

affect Debenhams negatively, as stores at higher prices. Hence, any plans for domestic expansion has to take effect immediately.

Government bond rates in the recent years have been rather low mainly due to the risk aversion of the investors and the Quanti-

there will be further declines in the real earnings growth and

Figure 18. UK real house price projections to 2023 with high and low growth scenarios (Source: PwC, 2013)

Debenhams plc. Analysts Report 2013 16

Social Trends and The Environment

Age distribution

Consumer confidence According to Reuters (2013), the British consumer confidence has reached its highest in more than three years. With the GDP dou-

Climate The performance of retailers is often influenced by weather was rather volatile in 2013 with a cold start to spring in April, conditions. The British climate

According to figure 19 Debenmiddle aged segment of the pop-

hams main customers are the ulation. The projections for 2033 show that the highest proportion of the UK population comprise of middle aged individuals, which benefits Debenhams in the longrun.

bling to 0.6% in the second quarter of 2013 and increased growth that the UK economy is showing signs of recovery. in the retail sector, it is evident

which hit the retailers hard and department stores such as De-

slowed down the growth of large benhams. However, according to from May 2013 the retailers en-

British Retail Consortium (BRC), joyed increased sales, with July

Figure 19. Debenhams Market Share By Age (Source: Debenhams Annual Report, 2012)

experiencing a 2.2% growth. The growth in July, which was the highest in seven years, was due to that months heat wave (BBC,

Figure 20. The Changing Shape of the UK Population (Source: ONS, OECD, 2009)

2013). BRC further reported that which is relatively lower than

online sales grew only by 7.9%, other months. This shows the on consumers, which encourages them to leave houses and visit high street shops.

positive impact of a good weather

17 Debenhams plc. Analysts Report 2013

Figure 21. UK Consumer Confidence (Source: GFK, 2013) Technological Advancements The retail industry in the recent years experienced rapid growth in sales through multi-channel structures to improve mobility

by Mobile point-of-sale and some other devices, which improve inservices, and the companys security (Aruba, 2013). ventory management, customer

and e-commerce. Department first-hand witnessed the rapid growth in online sales, which at

stores such as Debenhams have

times were at rates of around 200%, over only a one year period.

According to a forecast, all these are expected to

new technologies stated above 2.4bn to the total sales in retail an, 2013).


Some of the modern technologies currently used by many retailers include interactive televisions, in-store technologies, augmented reality, image recognition and smart devices (The Guardian, 2013). Companies such as Aruba have designed networking infra-

by the end of 2013 (The Guardi-

Debenhams plc. Analysts Report 2013 18

2.3 Industry Analysis and Competitive Environment

The industry in which a company competes is a major element in understanding the companys environment. The industry can panies which produce goods that be described as a group of comare close substitutes of one another. The structure of the indusrules, as well as the strategies ter, 1980). try determines the competition available to the companies (PorPorter further discussed that

Threat of Entry - MODERATE / LOW

Economies of Scale High In the past few decades there has been a decrease in the number of independent retailers. The increased size of many UK departorganizational structures ment stores and their vertical Capital Requirements Moderate/High Entering the retail industry may require relatively high capital investments. The entrant has to keting, set-ups, licensing, product registration and contracts with market share.

incur costs for advertising, mar-

enabled them to enjoy maximised cost efficiency and economies of scale, which in turn has resulted in the reduction of the prices of their goods. While it is not impos-


suppliers in an attempt to gain An article by the office of fair trad-

in an industry the state of the competition is dependent on five forces put together determine the competitive forces. These five potential profitability of the comPorters five forces, the competiis analysed.

sible to break the entry barriers, the competitive advantages of incumbents due their cost advantages make entry virtually impossible.

ing noted that although it has yet

not been proven whether capital

requirements constitute barriers to entry, they definitely slow it down. pear to raise capital relatively easier than the entrants (OFT, 1997). Incumbent retailers ap-

pany in the industry. By utilizing tive environment of Debenhams

Figure 22. Porters Five Forces (Source: Porter, 1980)

19 Debenhams plc. Analysts Report 2013

Cost advantages Independent of Scale - High Factors such as long-term relational contracts with suppliers, having first move advantages in accessing favourable geographical locations and steep experience curves have given incumbents absolute cost advantages of entry (OFT, 1997).

Legal Barriers Moderate/Low Government policies such as the planning regulation of 1996, and certain licensing and emission standard requirements may deter entrance into the retail industry. However, in 2011, the British government put into effect its plan for growth policy,

Access to Retail Sites Moderate For retail stores such as Debengeographical locations is of vital

hams, having access to prime importance (OFT, 1997). Access to retail sites is often considered a barrier to entry, when there

and have resulted in deterrence

which resulted in the removal of 130 out of the 257 restrictive regulations, and the simplification of some 30 other regulatory policies. This was in an attempt to promote the growth of small businesses, decrease bureau-

have been governmental and set restrictions and limitations

regulatory interventions, which on the entrants (OFT, 1997). For instance in 1996, the implementation of planning regulations by in the rapid decline of planning

Figure 23. Threat of New Entrants

Threat of New Entrants

Economies of Scale 5 4 3 2 1 0

cracy and stimulate the economy (BBC, 2011).

the British government resulted grants to large retailers. This policy required retailers, which were planning on opening stores that were over 2,500 square me-

Access to Retail Sites

Capital Requirements

ters in size, to pass a sequential 2008).

test and a test of need (Sadun,

Legal Barriers

Cost Advantages Independent of Scale

Figure 24. Planning Regulations of 1996 (Source: Sadun, 2008)

Debenhams plc. Analysts Report 2013 20

Rivalry Amongst Existing Competitors HIGH

Concentration Moderate/High In 1980s, following the relaxation Industry Growth Slow As discussed earlier, in July 2013 by 2.2%. This rapid growth has been mainly due to the desiraaverage growth in the retail ble climate in this month. The industry for the year 2013 has been forecasted to be rather flat, which is similar to the growth in 2012. However, the street retail sales are expected to continue at a rate of 0.3% in real terms, Ratio of Fixed to Variable Costs Moderate/High The major fixed costs of retailers are the land and store fitting out costs. Furthermore, the rental

of the restrictions on UK retailers, many companies took advantage of the growth cycle by increasing their sizes and market concentrations. Department stores such John Lewis and House of Fraser have increased significantly in size and have taken a considerable share of the overall market.

the high street sales increased

costs are not linked with the sales performance of the company and rents generally increase regard-

as Debenhams, Marks & Spencer,

less of the overall performance Teller, 2010).

of the market (Burt, Sparks, & On the other hand, the major labour force. However, according to a study, 60% of the UK retail

declining, with total sales having

variable cost of retailers is their

been estimated to fall by -1.9% for the fourth subsequent year (Retail Research, 2013). The slow growth in the UK retail industry

employees are part-time and also work part-time. This gives

64% are female, 70% of which flexibility to the retailers and

means that companies must comcapture market share.

pete fiercely in order to be able to

allows them to reduce their var-

iable expenses (Burt, Sparks, & of fixed to variable costs is relatively high.

Teller, 2010). Therefore the ratio

21 Debenhams plc. Analysts Report 2013

Switching costs Moderate Department stores such as De-

Exit Barriers Moderate/Low The assets of retailers are often not specialised and can be easily moved to more profitable regions or get liquidated. Furthermore, the retail industry is not highly intervened by the government regulatory barriers from exiting some social aspects to this. For instance, exit from the industry by and hence, there are limited the industry. However, there are

benhams and Marks & Spencer

have managed to reduce consumers search costs by providing a one-stop shopping service and offering a wide range of relatively similar products (OFT, 1997). According to the office of fair trading (1997) search costs and shopping costs have both contributed in switching from their regular retailers. Furthermore, as long as the quality of consumers retail

to the reluctance of consumers

giants such as Debenhams, which would result in many job losses and may have an adverse impact economy. There is further the is-

have over 30,000 employees

services do not decrease signifi-

cantly, individuals would rather stick to their usual retail stores and avoid incurring search costs. Figure 25. Rivalry Among Existing Competitors

on the overall well-being of the sue of emotional barriers and the make economically justified exit decision (Porter, 1980).

managements unwillingness to

Debenhams plc. Analysts Report 2013 22

Threat of Substitute Products - HIGH

Substitute Products High There are many substitute prodSubstitute Services High The growth in the retail industry in 2012 was around 0.5%, however, most of this growth was mainly due to the rapid increase in

Bargaining Power of Buyers - LOW

According to the office of fair

trading (1997) the end-consumer as Small, Immobile and Uninformed. Customers have been characterised as being small, since their purchases constitute tomers total expenditures and have been further regarded as

ucts offered by retailers with Fashion clothing, accessories

of retail stores can be described

similar functions and purposes. and home furniture are easily

replicable and can be produced at relatively low costs and sold at reasonable prices.

the sales of online retail services, the total retail sales in 2007 and

which contributed to only 3% of increased to over 10% of the total sales by 2012. The sales growth ative in the past four years. The of street retailers has been negrapid growth in e-commerce and

only a fraction of both the cusretailers total sales. Consumers being immobile, since they prefer avoiding search and shopping costs and are therefore not will-

online services is expected to create many substitute services and strip a large share of the market from physical retailers.

ing to travel far distances in the pursuit of finding appropriate uninformed, as they do not have products. Finally, consumers are any knowledge about the availand their qualities. Due to all

ability of products, their prices these characteristics, it is clear Figure 26. Average Internet Retail Sales (million) (Source: ONS, 2013)

that the consumers have little to

no bargaining power (OFT, 1997).

23 Debenhams plc. Analysts Report 2013

Bargaining Power of Suppliers - LOW

UK retailers desire to sell high quality products and they often and conducting quality controls ing process in order to ensure that do this by carrying inspections or by managing the manufacturthe products meet the required metry of information between by managing the supply process. Furthermore, a retailer such as about its reputation and wants to Debenhams, which is concerned maintain its perception on exclu-

sivity, may require its suppliers retailers (OFT, 1997).

standard. When there is asymFigure 27. Analisys of Porters Five Forces the suppliers and retailers, the retail companies may intervene

to avoid supplying to any other Retailers as the sellers of final goods are closest to the end-consumer and have detailed information about

Therefore, the market power has


been shifted towards retailers the supply chain management is often carried out by the retailers (OFT, 1997).

and away from the suppliers, as

Figure 28. Five Forces of the Retail Industry

Competitive Threats
Threat of Entry MODERATE / LOW Industry Competition HIGH Threat of Substitutes HIGH

Industry Profitability MODERATE

Buyers Bargaining Power LOW

Suppliers Bargaining Power LOW

Bargaining power of Suppliers/Buyers

Debenhams plc. Analysts Report 2013 24

2.4 Analysis of Debenhams Business Strategy

Strategic Objectives This section briefly outlines Debenhams strategic line with the maximisation of the shareholders value. The majority of this information annual report and the companys by referring to external sources plans have been helpful in immance. External sources are also perspective on the companys strategy. proving the firms overall perfor-

and the actions which have been undertaken by the firms management in the pursuit of these goals. It is important to comprecompany is aiming at, as this will hend the direction, at which the enable understanding whether the goals of the company are in


to identify, whether Debenhams

has been retrieved from the 2012 website, which merely summaplans. Where necessary, the com-

the means of providing outside

rize the companys strategic panys objectives are evaluated

Figure 29. Four Objectives of Debenhams Corporate Strategy (Source: Debenhams Annual Report, 2012)

25 Debenhams plc. Analysts Report 2013

First objective
Focusing on UK retail The first objective of Debenhams

Second objective

Third objective

Delivering a compelling cus- Increasing availability and choice through multi-channel tomer proposition Debenhams (2012) is planning Debenhams focus in 2013 is on to offer its customers a unique, increasing the choice of brands, lection of brands. They have also are sold online and offering a been attempting to improve per- better range of delivery options. differentiated and exclusive col- products and categories, which formance by raising the stand- This is a wise objective, as in the as increasing the marketing and growth in e-commerce sales to online (Internet Retailing, 2013). e-commerce turnover

(2012) has been the modern-

isation of 30 of its 154 stores, Debenhams claims that the sole is meeting the demand of its

which had remained un-invested. purpose of this modernisation customers for a modern shop to on the Debenhams brand. They

improve customers perceptions further aim at improving the

ards of visual merchandising and first half of 2013, Debenhams in-

product differentiation as well terim statements showed a 46% advertising expenses in 2012, 194.4m. Furthermore, 12.7% of which have supposedly increased Debenhams sales are generated their sales. Debenhams has shown its pride the sales participation, which in 2011 to Debenhams is hoping to increase

choice offered in their stores so that it meets the local demands. to increase the number of the UK stores by opening and operating Debenhams is further attempting

70 new stores, which they believe

on the companys own-bought 600m in the medium-term.

will increase their sales by 1 scale. The new stores that were

billion and result in economies of opened in 2011 increased sales by 5.8% and created 350 jobs (Debenhams, 2011).

constituted 80.4% of their total One of Debenhams other focuses sales. However, in 2010, the City is to develop its mobile strategy. traders were shocked by a fore- An investigation conducted by the cast-busting 18.6% increase in company showed that in 2012, when the like-for-likes 2010). Debenhams only raised by 0.3% (Shields, higher than the industry average this modest increase with the Debenhams mobile phone sales own-brand offer at the expense 2013). of concessions (Shields, 2010). This justification may have been reasonable, as in 2013, Deben3.1% (Internet Retailing, 2013).

the pre-tax profit to 123.6m, 27% of all the store visits were were from mobile devices, which is explained of 15%. In the first half of 2013,

companys attempts in shifting increased by 265% in comparison store space to its higher margin with 2012 (Internet Retailing,

hams like-for-like sales rose by

Debenhams plc. Analysts Report 2013 26

Fourth objective
Expanding the brand internationally Debenhams (2012) believes volatile economic environment is expected to stabilise. Table 2 indicates that although Ireland

that opening franchise stores is a low-cost, low-capital way to expand the brand in distant and emerging markets. In 2012, Dekets of Russia and Pakistan and

had negative growth in sales recovery.

every year, it also showed signs of Debenhams (2012) has further noted that there has been expanretail. Their strategy is said to sion in their international online be two-fold. For their major markets, they plan on developing country specific websites. These are to be designed in such way that the websites are presented in the local language and trades occur in local currency. The smaller

benhams entered two new marthey further opened new stores in India, the Philippines and Iran. In 2013, they plan on opening markets.

new stores and entering new Debenhams owns eleven stores in Ireland and six in Denmark, which trade as Magasin du Nord. Debenhams (2012) believes that

Magasin du Nord , which had a has been performing well and been achieved through Deben-

markets however, will have to

32.14% increase in sales in 2011, has increased margins. This has hams own brands and Magasins segment, which has suffered in

use overseas delivery from the

UK. Debenhams has further stat-

ed that during the course of the year, the number of countries they delivered products through their website

branded volume lines. The Irish the previous years due to the

has increased from 7 to 66. They further plan on expanding in 30 more countries.

27 Debenhams plc. Analysts Report 2013

2.5 Debenhams Competitive Advantages

Distinctive Capabilities In a world with an ever so competitive business environment, it have attempted to create distinctive capabilities in the pursuit is not surprising that many firms Architecture Kay (1993) identified architeces of distinctive capability. He which have created organizational knowledge and routines and as a result enhanced the flexand exchanging information in ated valuable architecture. An architecture which adds value

ture as one of the main sourcexplained that the companies,

to the firm is the result of relational contracts. These contracts are implicit and in contrast with

of competitive advantages. Kay (1993) identified these distincreputation, and innovation. tive capabilities as architecture,

the classical ones do not have each and every expectation and responsibility written in the terms of the contract.

ibility of the business by sharing volatile circumstances have cre-



pends on the ability of the firm to build and sustain long-term relationships and to establish an environment that penalizes opportunistic behaviour (Kay, 1993).

Figure 30. Corporate Architecture Structure by Kay (1993)



Suppliers & Customers

Collaborating Firms

Debenhams plc. Analysts Report 2013 28

Debenhams Internal Architecture

Many successful firms have man-

aged to create a set of routines, styles and structures, by which they consistently performed well regardless of the economic enviby employing the most talented

Debenhams has adopted certain strategies within the organization with the aim of creating a

benhams internal architecture was mainly retrieved from sources published by Debenhams and therefore, it is somewhat biased. Reviews by former employees although Debenhams has es-

The information regarding De-

sense of common purpose among its employees and promoting organizational knowledge, as well as individualistic excellence. The

ronment. They have done this not employees, rather by utilizing

ordinary employees in achieving has been the result of creating

points in figure 31 outline the nature of the relationship of Deoverview the schemes and plans benhams with its employees and developed by the management, which aim at improving the overall performance of the company. It is clear that Debenhams encourages both team work and individual perfectionism by the personal development plans.

of the company revealed that tablished the above strategies, they may have not been able to implement them as efficiently as employees rated

extra-ordinary performance. This organizational knowledge and routines and setting a co-operative ethic (Kay, 1993).

possible. A sample of 28 former 2.9 out 5 stars, while the former Debenhams

Debenhams is a large enterprise with over 30,000 employees. Creating and sustaining a co-operative ethic in such a large or2

employees of Marks & Spencer gave M&S a rating of 3.4 stars. Furthermore, while 82% of reviewers recommended M&S as a desirable work environment, hams (Glass Door, 2013).

ganization, especially one which often a challenging task. In order for an organization to sustain such co-operation, there should is based on deep relationships is

means of incentive schemes and They have created a consummate

only 52% recommended Deben-

co-operative ethic by acknowlopinions matter and influence

edging employees that their the strategic direction of the firm. opportunistic behaviour by havand promoting whistle-blowing against unethical behaviour.

be a sense of common purpose and goal among all employees (Kay, 1993).

Debenhams further condemns ing set a business code of conduct

29 Debenhams plc. Analysts Report 2013

2 A consummate co-operation as opposed to a perfunctory one.

Figure 31. Debenhams Employee Scheme Rewards & Incentives Good performance of the teams and individuals are rewarded through employee recognition scheme and cash. In 2008, the company developed the Share Incentive Plan, which is an unapproved plan operated by the company, directed towards the companys senior managers

Growth Opportunities

Valuing Opinions

Debenhams personal development plan, allows any employee to grow their careers. According to Debenhams in 2011, 89% of retail managers and 69% of senior executives were appointed internally Debenhams values the opinion of its employees and the senior management team is obliged to listen and act on feedbacks (Debenhams Annual Report, 2012).

Recognition of Talents

A Sense of Common Purpose

Employees are encouraged to express their talents. This is a good indication that relational contracts exist within the internal structure of Debenhams. Expressing talent is an act, which is complex in nature and difficult to define in the terms of the employment contract.

Opportunistic Behaviour

In order to create a sense of common purpose among the employees, Debenhams attempts to highlight the importance of each individual and the role they play in the overall success of the company. This is done by sharing business information regarding the Debenhams performance, and by recognizing the teams and individuals who contributed to this success. In order to confront opportunistic behaviour, Debenhams has developed the code of business conduct and the anti-bribery and corruption policy. It encourages its employees to report acts of unethical behaviour by any individual. Debenhams enables its employees to invest in their future by giving access to defined contribution pension scheme with Legal & General.

Pension Schemes Other Benefits

Finally some other benefits offered to the employees are employee discounts, holiday packages and flexible working hours.

Figure 32. Debenhams (left) and M&S (right) Ratings (Source: Glass Door, 2013)

Debenhams plc. Analysts Report 2013 30

Debenhams External Architecture The external

Debenhams concerns its relacustomers.



A firm to sustain its architecture

tionships with its suppliers and External architecture is found where firms share knowledge or establish fast response times, on the basis of a series of relational contracts between or among them (Kay, 1993). Developing relational contracts

needs to create long-standing redirect sourcing for a long time enabling it to create long-standing around the globe.

with the suppliers would further allow the company to improve the management of input costs. Furthermore, these relationships

lationships. Debenhams has been

relationships with its suppliers Access to large number of supworld and long-standing relationships with them has enabled Debenhams to share product aware of changes in the custom-

mutually benefit both parties as mising sustainable fulfilment and costs (Annual Report, 2012). Unfortunately, in 2013, Debenhams was criticized for bullying its suppliers and forcing them to there have been reports that Debenhams was taking advantage of they both have the goal of opti-

pliers in different regions of the

with suppliers is of high impor-

tance as it promotes the sharing

of product knowledge and en-

courages flexibility of response (Kay, 1993). The benefits of relational contracts are particularly valuable in fashion retailing,

knowledge more flexibly and stay ers fashion tastes in different areas of the world. Hence, the sourcing strategy of Debenhams country slogan, combined with

cut prices by 2%. Furthermore,

some of its suppliers by delaying payments up to 120 days instead of 90. If such opportunistic acts are continued by Debenhams, it

where the needs of the customers changes frequently and there is strategic posturing by both parties (Kay, 1993).

based on the right product, right its relational contracts with the

could result in the destruction of its long-standing relationships with the suppliers, which would

suppliers has been translated into an effective external architecture. Debenhams believes

adversely affect the companys performance (Loveless & Craven, 2013).

that long-standing relationships

31 Debenhams plc. Analysts Report 2013

Networks With regards to the relationship with customers, A group of businesses, which have created relational contracts with one another are referred as

Figure 33. Direct Sourcing (Source: Debenhams Annual Report, 2012)

has been improving its ability in meeting the demands of the local markets by offering more flexible


networks. There are 26 international designer brands that are sold by the Debenhams stores across several countries. They have created relational contracts

ways of shopping (through multi-channel) and by responding fast to any changes in the tastes of communications. Debenhams has been able to increase online sale by 265% from 2012 to 2013.

the consumers through enhanced

with these designers with the aim of better understanding the demands of the local markets and improving their product knowledge. Fast response times be-

tween these collaborating stores performance.

has allowed all parties to improve

Debenhams plc. Analysts Report 2013 32

Reputation Kay (1993) regarded reputation products. Debenhams has been in existence for over two centuries and its ability in sustaining the may have had a positive impact in the past decade. It has expand-

as the second source of distincmean by which information about

tive capability. Reputation is the a business is transferred to the

ed the business considerably new stores and franchises in the different regions of the world. It has further introduced many new increased marketing and adver-

business over such a long period on its reputation. However, the longevity of the business may not be a good indicator for assessing its reputation. Debenhams has gone through dramatic changes

in the recent years by opening

consumers. Reputation is of high value in the markets where the quality of products is important and can only be realized over a

designers to the business and has tising in multichannel. All these

long period of experiencing those

changes appear to have had pos-

Figure 34. Value Chart (Source: YouGov, 2013)

Figure 35. Quality Chart (Source: YouGov, 2013)

33 Debenhams plc. Analysts Report 2013

itive impacts on the companys

reputation. The introduction of own brands, UK brands and inter-

Debenhams for its quality and value has remained stable in the past few has been able to sustain its repuenvironment. years. This shows that Debenhams tation in a rather volatile market Debenhams has established a systematic approach of identifying, assessing, analysing and managing the day basis that could adversely affect its reputation and cause a loss of

diverse selection of Debenhams nationally recognized designers has improved Debenhams reputation for contemporary quality Price Shopping, 2013).

fashion and furnishing (Best-CDFurthermore, Debenhams profit

scare in the first half of 2013, which caused its share prices decline rapidly, did not change the perception of consumers on Debenhams reputation. The YouGov brand index indicated that the brand perception of

risks the company faces on a day to

stakeholders trust. Below some of

these risks have been identified and courses of action have been defined in response to these risks.

Figure 36. Management of Reputational Risk (Source: Debenhams Annual Report, 2012)

Debenhams plc. Analysts Report 2013 34

Innovation Innovation is usually considered as a source of competitive advantage, only when it is accompanied by other distinctive capabilities. Kay (1993) noted that often At a recent presentation in Lon-

Strategic Assets The strategic assets of a firm, as deof competitive advantage, which

don, Debenhams head of digital operations discussed the recent e-commerce and multi-channel innovations of the company in and its effects on the companys developed what is referred as

scribed by Kay (1993) are sources concern the companys dominance to its distinctive capabilities. De-

times the rewards of the architecture of a company are mistakenly credited to innovation. In recent years, Debenhams experienced high levels of innovation and development in e-commerce and multi-channel. In September 2011, Debenhams claimed that smart-phone technology

or market position as opposed benhams strategic assets in 2012 included the acquisition of licenses and trademarks for a total value of 7.2 million. Furthermore, Debenhams has incurred expenses on the marketing and advertising division

performance. Debenhams has an agency like innovation. This

new approach adopted by the testing a new product or technology in a small scale before developing it further. This has enabled the company to develop new technology and innovation at half

company, is simply the means of

it had developed an innovative

of the business. Debenhams has also invested over 5m on mulhave allowed it to capture a larger ability in opening and operating ti-channel and e-commerce, which portion of the market. Finally, their 75,000 square feet department

which printed advertisements were brought to life . They further launched a virtual shopping ers to try on range of clothing by downloading an application (MacDonald, 2013).


the previous time scale. However,

this approach has resulted in the fragmentation of the companys architecture and the enhancement in the innovation in the past few years has been somewhat at ity. (Payne, 2012)

innovation, which allows customin an augmented reality, simply

stores has enabled to increase economies of scale and operate more cost effectively. All these strategic assets to some Debenhams as an incumbent has be made by entrants who are aim-

the cost of the companys flexibil-

extent act as barriers to entry, as incurred sunk costs, which need to ing at capturing some share of the economies of scale and the companys large investments in acquiring share all may deter entry. licenses and capturing market

market. The size of Debenhams, its

35 Debenhams plc. Analysts Report 2013

Pointing the phone at printed advertisements in magazines would open Debenhams website and play the advertisement on the smart phone.

2.6 Debenhams Market Choices

In order for a company to take full advantage of its distinctive capabilities, it needs to choose an issue, which is often faced by needs to be made by taking both the geographical and product

While supply factors define the

industry, the markets are defined once was a part of the Burton Group has been known for de-

profiling their customers. They

the appropriate markets. This is companies, as the market choice

by demand. Debenhams, which

found this to be a more efficient way of running the stores. By 1993, apart from the Debenhams department stores (which at the group), all Burton shops targeted This was the main reason that the

fining its target market rather been aiming at individuals of all

too broadly. Debenhams has ages and both sexes. The figure

time were a part of the Burton a specific segment (Irwin, 1998). Burton Group de-merged from Debenhams defined their target

dimensions into consideration. as reputation and architecture,

For distinctive capabilities such the appropriate market is iden-

below shows the segments of the in comparison to some other UK

market targeted by Debenhams stores. The Burton Group has targeted a much smaller segment of the market. In fact, their main

Debenhams, as they believed markets too widely. The main deis by males and females of 33 to

tified by the nature of demand for that product (Kay, 1993). For innovation on the other hand, the

mand for Debenhams products 55 years of age, who are not nec-

technical characteristics of the

product determines the appropriate markets in which innovation translates into a competitive advantage.

objective in the past few decades has been targeting a specific, The Burton Group started definsingle gender market. In 1980s, ing segments for the market and

essarily interested in designer labels, but do respond to brand names (Koenig, 2013). Even though it is often difficult

Figure 37. Debenhams Target Market (Source: Irwin, 1998)

to extend reputation outside the

geographical region in which the

market was created, Debenhams

has opened stores and franchises however, could be due to econ-

in other areas of the world. This omies of scale, as a firm with a market could benefit from servnot have competitive advantages in those markets.

competitive advantage in one ing other markets even if it does

Debenhams plc. Analysts Report 2013 36

37 Debenhams plc. Analysts Report 2013

3.1 Introduction

This section of the report analyses Debenhams from a financial perspective. It attempts to de-

Due to the limitations that have

been set upon this assignment, the accounting policies of the companies could have not been discussed in the main body of the

termine whether the companys performance is in line with its stated goals and strategies (Palepu, Healy, &Peek, 2010). extensively be A companys performance can conducting Ratio and Cash flow the relationship between the examined

Financial Analysis

text. A discussion of the impor-

tant accounting policies adopted the appendices.

by the companies can be found in


analysis. Ratio analysis examines various line items of Debenhams financial statements, while the hand attempts to assess DebenCash flow analysis on the other hams liquidity and how the firm manages its operating, investing and financing activities (Palepu, Healy, & Peek, 2010). Before con-

ducting the ratio and cash flow

analysis common-size statements will be produced with the aim of providing an overview of the Finally, some other financial

companys overall performance. measures will aid understanding the companys health, credit worthiness and its ability in sustaining long run profitability.

Debenhams plc. Analysts Report 2013 38

3.2 Accounting Adjustments

In order to make the analyses more accurate and the compaadjustments need to be made. operate in the United Kingdom and the company act 2006; as a nies more comparable, some Fortunately, Debenhams peers and have all adopted the IFRS result no adjustments are needed another4. However, some items on the financial statements required adjustments. Goodwill

Goodwill impairment chargfrom the income statement

es have also been removed

Nonrecurring Items

Nonrecurring items have been excluded from the analysis as they are one-off in nature and items such as profit and loss on pairment of assets and fair value ments.

to converge from one standard to

distort the analysis. These are the disposal of properties, imadjustments to financial instruInventory Valuation Although three of the companies use the retail method in deriving Brown group uses the FIFO meththeir costs of goods sold, the N od of inventory valuation. Con-

Although goodwill is not amortests are carried out annually to

tized in the income statement, determine whether it has been

impaired. If the goodwill is indeed impaired, it will not have any effects on the cash flow anal-

ysis; however some ratios such as return on assets, return on equity and asset turnover are affected, as they would show improved the write down. Thus: performance in the periods after Goodwill has been completethe analysis

verting this method of inventory valuation to that of its peers may the limitation of this report, no adjustments were made. aid the analysis, however due to

ly eliminated in performing

39 Debenhams plc. Analysts Report 2013

4 For instance, while the LIFO method of inventory valuation is not allowed under the IFRS, the US GAAP allows the use of this model. Furthermore, there are some discrepancies between the treatment of items such as finance income in producing cash flow statements and these distortions require adjustments.

3.3 Debenhams Common - Size Trend Analysis

Common-size statements nor-

Vertical Trend Analysis The vertical common-size analy-

malise the balance sheets and information that are more easily comparable across firms as well as for a single firm over time.

income statements, and provide

sis of Debenhams consolidated income statements attempts to determine the companys perforvertical common-size

Common-size statements further allow the quick identification of some financial ratios such as the gross profit, net profit, and the operating profit margins. Due to

mance in the past five years. The statements express each line item as a percentage of the companys income

the complex nature of the common-size balance sheets and the confusions that they may cause in comprehending the analyses, statements have been produced in this section.

total revenue. In 2010, there were a total of 5.4m exceptional costs operating profit. Due to non-rethat were deducted from the curring nature of these expenses, income and the operating profit figures.

only the common-size income

they were added back to the net

Table 5. Debenhams Vertical Common-Size Income Statement

Debenhams plc. Analysts Report 2013 40

Financial ratios such as the gross profit, operating profit and net tured by the vertical analysis. profit margins have been capFirstly, it is evident that the items on the common-size income statements remained rather stable. Furthermore, even though the net profit margin has been increasing consistently, the opermargins gradually

come statements indicates that

this decrease has been due to the drop in the percentage of net finance cost in these five years. Although the operating profit margin dropped by 1.72% from costs decreased more rapidly by

2008 to 2012, the net finance 3.07%, reducing this ratio from 3.82% to 0.75%. Figure 39 indicates that the most substantial panys net finance costs. change has occurred in the com-

ating profit and the gross profit over the five year period. Further analysis of the commonsize indecreased

Figure 38. Profitability Ratios

Figure 39. Vertical Analysis

Gross Profit Margin Operating Profit Margin Net Profit Margin

Gross Profit Margin Operating Profit Margin Net Profit Margin Net Finance Costs (%)

41 Debenhams plc. Analysts Report 2013

Horizontal Trend and Cross-sectional Analysis Horizontal common-size analysis is similar to vertical with the difference that the divisors are the first years items of Debenhams income statements. In this secrevealed that Ted Baker and N Brown group are also considered Debenhams peers. When the vertical common-size income statements were produced, cross-sectional analysis was not conducted. This is because the main ratios captured by the vertical analysis (e.g. net profit margin) have all been analysed extensively in the ratio analysis

tion cross-sectional common-size analysis has also been conducted. The main competitors of Debenhams are Marks & Spencer,

Debenhams gross profit has re-

mained rather stable in the past five years. Furthermore, although the companys distribution costs value in 2008, the operating

House of Fraser and John Lewis Partnership, of which only Marks & Spencer is a public company. Unfortunately,

have increased by 1.6 times its profit has remained almost un-

section of this report. However, for identifying the trends of revenue, operating profit and net profit across all the firms, the high value, as it shows the movethe sizes of the companies.

a cross-sectional analysis with


changed. Finally, the net finance costs have decreased significantly and the net profit attributable growth in these five years.

horizontal trend analysis is of ment of these items regardless of

only Marks & Spencer identified as a competitor is rather biased. As a result, a thorough research

to shareholders had a steady

Table 6. Debenhams Horizontal Common-Size Income Statement

Debenhams plc. Analysts Report 2013 42

1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 Figure 40. Revenue 0.0 Debenhams M&S N Brown Group Ted Baker 1.4 1.2 1.0 0.8 0.6 0.4 0.2 Figure 41. Operating Profit 0.0 Debenhams M&S N Brown Group Ted Baker 2008 1.0 1.0 1.0 1.0 2009 1.0 0.7 1.0 0.9 2010 1.1 0.8 1.1 0.9 2011 1.0 0.8 1.1 1.1 2012 1.0 0.7 1.1 1.2 2008 1.0 1.0 1.0 1.0 2009 1.0 1.0 1.1 1.1 2010 1.2 1.0 1.1 1.2 2011 1.2 1.1 1.2 1.3 2012 1.2 1.1 1.2 1.5

1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 Figure 42. Net Profit 0.0 Debenhams M&S N Brown Group Ted Baker 2008 1.0 1.0 1.0 1.0 2009 1.0 1.0 1.1 1.1 2010 1.2 1.0 1.1 1.2 2011 1.2 1.1 1.2 1.3 2012 1.2 1.1 1.2 1.5

43 Debenhams plc. Analysts Report 2013

From figure 40 it is evident that apart from Ted Baker, which experienced a 50% growth in sales, all

took the lead. Finally, it is evident

that the growths in the operating group remained rather stable in

In conducting the analysis adjustments were made to the net profBrown Group, Ted Baker and Marks its and the operating profits of N & Spencer. These adjustments

other companies increased revenue by only a margin of 10 20%. these companies are analysed, it will be shown that the movements Later on, when the share prices of

profits of Debenhams and N brown these five years. The stable operating profit of Debenhams along with that the companys operating costs have increased in this period. its increased revenue inidcates

were made due to the existence on the companies accounts, such

of some non-recurring expenses as exceptional items, profit and value adjustments, and non-GAAP the exceptional costs incurred by Marks & Spencer, many of these impacts on the analysis. An example is as shown below.

of their share prices appear to be somewhat correlated with the growth of their sales. Marks & Spencers operating profit

Figure 42 shows the net profit growth of the four companies. Debenhams had a consistent growth its value in 2008. This growth in

loss from disposal of assets, fair adjustments. Apart from some of

fell by 30% in five years. However, the largest drop occurred in 2009 where it fell by 30%. Ted Baker same year, but this drop was later

in net profit and grew to 160% of Debenhams net profit, which has been much higher than its peers has been due to the companys ability in reducing finance costs.

expenses did not have any material

also experienced a 20% drop in the on reversed and by 2012 Ted Baker

Figure 43. Marks & Spencers Exceptional Costs (Source: M&S Annual Report, 2011)

Debenhams plc. Analysts Report 2013 44

3.4 Time - Series Ratio Analysis

The value of a firm is determined by its growth and profitability achieved by quality operational

Profitability Profitability ratios are of high importance and are regularly watched by investors. The value deducted. This ratio is affected by consumers, industry and the general economic climate.

management, investment mandividend policy (Palepu et al, 2010).

agement, financial strategy and

of the firms and their stock prices are affected almost immediately by unexpected changes to these ratios. The main ratios for profitability include the net profit maron capital employed and return et al, 2012). gin, gross profit margin, return on shareholders equity (Cornett The net profit margin shows the percentage of the sales remaining after all expenses have been % 6 5 4 3 2 1 0 2008 2009 2010 4.82% 13.70% 23.57% 21.99%

The net profit margin of Debenhams has increased in the past five years. The trend has been generally upward (with an insignificant drop in 2010) and over a five year period this ratio had increased by about 2%. As it was it margin had a downward trend. shown earlier, the operating prof-

Ratio analysis attempts to determine whether the policies and the strategies implemented by have been effective in creating a

Debenhams in the past five years profitable and growing compa-

ny. Conducting ratio analysis on

Debenhams is initiated by the means of time-series analysis, which will provide a picture of the companys performance.

Therefore, the underlying reason in financing costs.

for this increase is the rapid drop

Figure 44. Net Profit Margin

Table 7. Debenhams Profitability Ratios 2008 Net Profit Margin Gross Profit Margin ROCE ROE 4.19% 14.55% 17.32% 61.53% 2009 4.96% 13.83% 18.71% 34.54%

2010 2011 5.30% 13.43% 25.37% 20.15%


2012 2012 5.62% 13.56% 19.29% 18.98%

45 Debenhams plc. Analysts Report 2013

Figure 45. Gross Profit Margin The Gross profit margin relates ratio is specifically of high value to retailers who desire to know 14.6 14.4 14.2 13.8 13.6 13.4 13.2 13 % 2008 2009 2010 2011 2012 Figure 46. ROCE 14 %

gross profits to the sales. This

how much the company profits by buying and selling, before any other costs have been taken into

account. Debenhams gross profit in the past five years, which tells of its stability.

margin has dropped by about 1%

Return on capital employed is a major financial ratio in determining Debenhams profitability as it

30 25 20 15 10 5 0 2008 2009 2010 2011 2012

indicates whether the company using the capital that it had em-

has been able to generate profits ployed. The capital employed by a company includes long term interest-bearing debt and the total

shareholders equity, which has

Figure 47. Capital Employed and Operating Profit m m

been adjusted for any distortions. In comparison to the previous two ratios, the ROCE experienced significant changes. The return on capital employed increased by

1200 1000 800 600 400 200 0 2008 2009 2010 2011 2012

200 195 190 185 180 175 170 165 160

about 10% from 2008 to 2011, before dropping in the year 2012. Figure 47 reveals that the volatility of ROCE has been due to a

rapid increase of operating profit

Capital Employed Operating Profit

Debenhams plc. Analysts Report 2013 46

Management Efficiency in the years 2008 to 2010, which was later followed by a sudden decline. Asset management ratios attempt to determine how effiits assets. They further aim at ciently Debenhams has used analysing Debenhams efficiency in managing its accounts payable the inventory turnover ratios are (Cornett et al, 2012). Asset and two important ratios in analysing the efficiency of companies within the retail industry. The invenhow many pounds of sales were eration. The inventory turnover trend in the past five years has this change has not been signifibeen downwards; nevertheless cant. The asset turnover ratio had experiencing a drop in 2012. Average inventory

Return on equity shows the return to the companys investors and the common equity shareholders. Shareholders have invested in the companys assets and need to know whether they investments. In short, this ratio

increased slightly by 2011, before turnover

are getting any returns from their shows the relationship between the net profit and the shareholders funds. The return on compa-

period measures the number

tory turnover ratio determines produced by one pound of invenasset turnover ratio is similar to the inventory turnover ratio,

of days that the company holds the inventory before selling it to the customers. It is in the best

nys common equity has dropped rather rapidly in the past five years. In 2008, the return on dropped to about 20%. equity was 60% and by 2012 it

tory (Cornett et al, 2012). The

interest of the company to have a low figure for this ratio, as it tory management (Cornett et al, is an indication of quality inven2012). The trend in the average been upwards, which could mean

with the difference that instead company are taken into consid-

of the inventory, the assets of the

inventory turnover period has that the companys inventory management has deteriorated in the past five years. However, it is small figure is not necessarily a

Figure 48. ROE %

70 60 50 40 30 20 10 0 2008 2009 2010 2011 2012

important to highlight that a very good sign, and is often considered a red flag, as it may mean that the inventory (Cornett et al, 2012). company does not have sufficient Trade receivables collection pe-

riod measures the length of time

47 Debenhams plc. Analysts Report 2013

that takes the company to collect

its accounts receivable. A low figshould attempt to collect receiv-

ure is preferred as the company ables as fast as possible in order to reduce its financing costs. It is evident that this figure has

Figure 49. Average Inventory Turnover Period days

64 62 60 58 56 54 52 50 2008 2009 2010 2011 2012

remained unchanged in the past

five years. A very small figure could simply mean that the com-

for the average collection period pany has a very strict receivable

policy, which may result in cuscompeting firms.

tomers buying products from Figure 50. Asset and Inventory Turnover Ratios 7 6 5 4 3 2 1
Asset turnover ratio

The trade payables settlement period is the length of time it takes the company to pay its creditors. The management often prefers payable as slowly as possible. This is because the company will the company to pay its account

be able to delay obtaining higher cost sources of financing (Cornett et al, 2012). This measure has de-

2008 1.81 6.62

2009 1.97 6.49

2010 2.56 6.46

2011 3.05 6.21

2012 2.46 5.90

Inventory turnover ratio

Table 8. Debenhams Management Efficiency Ratios (in days) Average inventory turnover period Trade receivables collection period Trade payables settlement period Cash conversion cycle 2008 55 12 109 -42 2009 56 12 103 -34 2010 56 12 95 -26 2011 59 12 94 -23 2012 62 12 96 -22

Debenhams plc. Analysts Report 2013 48

creased by about 15 days in the

past five years (see fig. 51). There ment in 2012. A very high figure

liquidity and is also useful in un-

were however signs of improvecould be due to the company abusing its credit terms, which could result in suppliers revoking ing on an account (Cornett et al, 2012). the companys ability in purchas-

derstanding the companys effiaccounts receivable and accounts payable. Debenhams cash

the suppliers are paid only after from the customers.

ciency in managing its inventory,

all collections have been made As it was seen earlier the trade payables settlement period had decreased over the years, which may have been due to stricter credit terms by Debenhams suppliers. Furthermore, the avappears to have deteriorated in

cycle is negative, which is an in-


dication of quality management. However, it is important to highlight that negative cash cycles are not sustainable in the long run, which explains its increase in the past five years. This is because a

All the above measures are useful

erage inventory turnover period these years. These in turn have increased Debenhams cash conversion cycle.

in deriving what is referred to as is a measure of the companys

the cash conversion cycle, which

negative cash cycle implies that

Figure 51. Trade Payables Settlement Period days days

Figure 52. Cash Conversion Cycle 2008 2009 2010 2011 2012

115 110 105 100 95 90 85 2008 2009 2010 2011 2012

-15 -20 -25 -30 -35 -40 -45

49 Debenhams plc. Analysts Report 2013

Liquidity Liquidity ratios measure the companys ability in meeting its short term obligations. They attempt to determine the relacurrent assets and current liabilities (Cornett et al, 2012). In tionship between the companys All three ratios indicate that Demeans that Debenhams does not meet its short-term obligations.

benhams liquidity increased sigwas followed by a major drop in following the year 2010 was

nificantly in the year 2009, which the 2010 (see fig. 53). The trend stable without any significant ratio. However, the current ratio experiencing only a marginal

have enough current assets to It is important to note that even guard the company against li-

though high levels of liquidity quidity crises, they come at the cost of lower profits. This is because liquid assets do not gener-

the previous section, the cash conversion cycle revealed that the companys liquidity has been decreasing in the past five years. However some other ratios will trend in the companys liquidity. better aid understanding the The first ratio analysed in this

changes in the cash and quick increased from 0.4 to 0.6 before growth in 2012. The most important issue to consider is that all ratios are below 1.0, which

ate much revenue for the company. Higher levels of liquidity could management of the firm. be a major signal of inefficient

section is the current ratio, which is the broadest of all liquidity measures, as it includes all the companys current assets. Quick ratio is another measure for evalexcludes inventories5 from the

Figure 53. Liquidity Ratios 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 Current Ratio Quick Ratio Cash Ratio 2008 0.54 0.16 0.07 2009 0.88 0.42 0.31 2010 0.41 0.13 0.06 2011 0.59 0.14 0.04 2012 0.63 0.16 0.06 x

uating the firms liquidity, which current assets and as a result panys liquidity. Finally the cash ratio measures liquidity by only including cash and marketable liquid assets of the company.

give a better view of the com-

securities, which are the most

The least liquid of current assets Debenhams plc. Analysts Report 2013 50

Capital Structure and Debt Management Some other measures for examining the liquidity are cash flow are not prone to manipulations, ratios. Since cash flow statements cash flow ratios are very popular among analysts, as they are more reliable. Therefore, to get a better view of the companys liquidity, a few other ratios have been analysed. This section analyses Debenhams an understanding of the extent to which the company has been financed with debt. The capital ruptcy. Often companies in the profitable, are the ones that have debt.

capital structure, in order to give

industries, which are not very been financed with high levels of In order to analyse Debenhams levels of the companys total debt have been examined as shown in

structure employed by Debenhams management, influences its viability as a long-term entity (Cornett et al, 2012). A company which has been financed with high levels of debt may be able

capital structure, the trend in the and its total shareholders equity figure 56. Only long and shortterm interest bearing debts were included in the calculation of the total debt.

The cash coverage and the in-

terest coverage ratios have increased in the past five years. Specifically, the interest coverage ratio has grown significantly in

to provide higher cash flows to its stockholders; however, this at the cost of companys bankincrease in cash flows may come

these years and this has been financing of Debenhams.

mainly due to the reduced cost of

Figure 54. Cash Flow Analysis of Liquidity

16 14 12 10 8 6 4 2 0 2008 2009 Cash coverage ratio Interest coverage ratio Cash generated from operations to maturing obligations 2010 0.28 2.21 4.23 2011 0.37 2.66 7.84 2010 2011 2012

x 0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0

Table 9. Debenhams Analysis of Liquidity Using Cash Flow Ratios Cash generated from operations to maturing obligation Cash coverage Ratio Interest Coverage Ratio
51 Debenhams plc. Analysts Report 2013

2008 0.44 1.93 2.74

2009 0.39 1.89 2.73

2012 0.36 3.45 14.62

Figure 55. Debenhams Total Debt in 2011 & 2012 (Source: Debenhams Annual Report, 2012)

Debenhams had the highest level Figure 56. Capital Structure m

ing this year the company became less geared and the level of total shareholders equity increased. As it was shown earlier, the financing costs of Debenhams de-

of debt financing in 2008. Follow-

1200 1000 800 600 400 200 0 2008 2009 2010 2011 2012

creased dramatically in the past few years, which can be credited levels of debt. Furthermore, the to the decrease in the companys underlying reason for growth in shareholders equity is the decrease of the negative retained earnings of the company and the increase in its merger reserves.

Total Debt Total Equity

Debenhams plc. Analysts Report 2013 52

Market Value Ratios As shown in table 10 Debenhams gearing decreased significantly in the past five years, with the lowest level being in 2010. At the same time the level of interest In order to determine whether Debenhams share prices reflects the markets view on the companys future profitability, market important ratio to investors is return on equity does not show levels of debt financing. This inin the firms market prices, as kets view on the companys future performance.

formation can be easily observed they are a reflection of the mar-

coverage ratio increased from

value ratios have been used. An the return on equity; however, the increased risks that may be instance, the company may be

2.35 to 9.78. This means that in

2012 for each pound of interest pounds of operating profit available to cover the interest obli-

payment there has been 9.78

Figure 58 shows the share price performance of Debenhams from September 2008. In 2008 the

embedded in higher returns. For highly geared and the high re-

gation (Cornett et al, 2012). This increase in the interest coverage ratio has been mainly due to the decrease in financing costs in the past five years, as the operating years of the analysis.

share prices were at their lowest range, having hit figures as low as 20 pence per share. This decrease

turns may arise from increased m

Figure 57. Operating Profit and Finance Costs 250 200 150 100 50 0 2008 75 176.1 2009 62.7 182.2 2010 56.5 195.1 2011 27.3 183.7 2012 17.9 175

profit remained stable in the

Finance costs Operating profit Table 10. Debenhams Debt Management Ratios 2008 Gearing Ratio Interest Coverage Ratio 87.68% 2.35

2009 61.73% 2.91

2010 7.46% 3.45

2011 27.05% 6.73

2012 27.39% 9.78

53 Debenhams plc. Analysts Report 2013

in prices has been mainly due the increased level of investors risk aversion following the financial crisis and their reluctance in such as Debenhams. In 2009, the

Generally the increase in Debenthe markets positive sentiment

hams share prices in 2012 shows regarding the future profitability also somewhat correlated with

taking positions in cyclical firms prices increased significantly to from that date until 2012 the share prices experienced a moderate downward trend. Following prices increased

of Debenhams. This increase is the positive economic growth

about 100 pence per share and

forecasts. However, a profit March 2013, led into the decline conducted by YouGov, indicatchanged the consumers percep-

scare report that was released in of the share prices. An analysis ed that the profit scare had not tion on Debenhams, and hence, ensued.

the year 2012, Debenhams share reaching a peak price of 120 pence per share before dropping to a support level of 80 pence. significantly,

an upward trend in share prices

Figure 58. Debenhams Share Price Movement (Source: Financial Times, 2013)

Debenhams plc. Analysts Report 2013 54

tively stable in the past five years with the exception of a decrease in 2010. The stability of EPS has

Debenhams EPS has been rela-

12 10


Figure 59. EPS

been due to the consistency of the growth in the net income and the number of shares outstanding

8 6 4 2 0 2008 2009 2010 2011 2012 Figure 60. P/E

(see fig. 61). The reason for the

EPS drop in 2010 lies behind the two items.

disproportionate growth of these The price-earnings ratio relates 12 10 8 6 4 2 0

the market price of a stock to the pany. This ratio measures the pay for each pound that Deben-

earnings per share of the comamount investors are willing to hams earns per each share of its stock (Cornett et al, 2012). Figure ratio for Debenhams in the past 60 shows a rather volatile PE 1400 1200 1000 800 600 Shares outstanding Net income Table 11. Investor Ratios 400 200 0 m






Figure 61. Shares Outstanding and Net Income m

140 120 100 80 60 40 2008 2009 2009 10 7.27 0.48% 2010 2010 7.5 7.16 0.00% 2011 2011 9.1 5.33 2.76% 2012 20 0

2008 EPS(pence) P/E Dividend yield 9 4.63 17.20%

2012 9.8 9.69 4.11%

55 Debenhams plc. Analysts Report 2013

Du-Pont Analysis five years. However in 2012 there in this measure, which reflects a The first reason may have been the companys expanacquisition of Magasin du that are in a stage of growth sion into Denmark and the Nord in 2009. Many firms do not pay dividends; rather they reinvest the capital in the business. In the profitability sections it was Debenhams ROE declined expoof ROE, the Du-Pont Corporation

has been a significant increase generally positive sentiment towards the future profitability of the company. Dividend yield shows the cash Debenhams stock. It is a useful

shown that in the past five years nentially. Due to the importance invented a method by which the

ROE was broken down into three to five components, and each component was analysed individually. The Du-Pont Corporation

flow returns on investments on measure in analysing the amount

of cash flow an investor receives

The second reason may have been due to the companys large negative retained earnings in 2008 and 2009. An explanation may be that fol-

established that the ROE is a product of the net profit margin, uity multiplier ratios. total assets turnover and the eqThe return on equity is broken

for purchasing a stock. Debenhams dividend yield decreased significantly in 2009, dropping from 17.20% in 2008 to 0.48% in have been two contributing factors, which led to this decrease. Figure 62. Dividend Yield 18 16 14 12 10 8 6 4 2 0 2008 2009 %

2009. The author believes there

lowing the financial crisis the its losses, as opposed to paying dividends.

company decided to recover

down into three components, each of which measures the ment efficiency and its capital companys profitability, manage-

structure. Table 12 shows that management efficiency

the companys profitability and remained rather stable in the


previous years. The component which led Debenhams in having and then decrease exponentially 2010 2011 2012 been the decrease in the equity a high ROE of 61.53% in 2008, over five years to 18.98%, has multiplier, which is a measure of leverage. This is consistent with 2009 4.96% 1.97 3.54 34.54% 2010 4.82% 2.56 1.78 21.99% 2011 5.30% 3.05 1.25 20.15% 2012 5.62% 2.46 1.37 18.98% the previous findings, which showed that although in 2008 Debenhams was highly geared, significantly by 2012.

Table 12. Du-Pont Analysis 2008 Net Profit Margin 4.19% 1.81 Total Asset Turnover 8.12 Equity Multiplier ROE 61.53%

the debt financing was decreased

Debenhams plc. Analysts Report 2013 56

3.5 Cross - Sectional Ratio Analysis

In the previous section, time-series ratio analysis of Debenhams, aided to some extent the understanding of its performance over a five year period. However, time-series analysis on its own

Profitability According to the retail owner institute (2013) a key ratio for comparing the profitability of companies that operate in the Capital Employed. retail industry is the Return on Ted Baker had a significantly higher ROCE in comparison to its peers. Furthermore, Debenwhile in comparison, its peers all

sustained a somewhat stationary

ROCE. By 2011, Debenhams had Spencer and N Brown Group.

only gives a limited picture of the fore, conducting cross-sectional analysis is necessary for obtaincompanys financial health.

already outperformed Marks & However, in 2012, Debenhams ROCE declined by about 6%, which brought back its ROCE to roughly the same level as the N Brown Group and Marks & Spencer.

companys performance. There-

ing a more precise image of the The aim of cross-sectional analysis is to compare the performance of Debenhams with simthe same markets, have similar asset sizes, and operate in the similar manner to the firm being analysed (Cornett et al, 2012). It is often very difficult to identify identical firms that compete in the same market. Hence, the auin choosing suitable companies for conducting the analysis.

hams profitability from 2009 to 2011 increased by about 5%,

ilar companies, which compete in %

Figure 63. Profitability (ROCE)

45 40 35 30 25 20 15 10

thor has used his best judgement

5 0

2008 17.32 27.98 18.42 39.74

2009 18.71 18.94 18.07 32.15

2010 23.57 19.44 17.71 31.98

2011 25.37 18.20 18.66 33.93

2012 19.29 18.35 16.96 33.60

Debenhams M&S N Brown Group Ted Baker

57 Debenhams plc. Analysts Report 2013

Management Efficiency The inventory turnover ratio is the management efficiency of the

Liquidity The current ratio is the main measure for examining the liretail industry. quidity of the companies in the As it is evident from the graph below, both Marks & Spencer and Debenhams are illiquid as their A current ratio of less than 1.0 x indicates that the company will

a suitable measure for assessing companies. This ratio has been regarded as a key efficiency inretail industry. dicator for firms operating in the A very high inventory turnover ratio may mean that the company has not sufficient inventory or that the inventory is obsolete. A very low inventory turnover ratio on the other hand could be due

not be able to meet its short-term obligations should such obligations arise. Both N Brown and uid, however as discussed earlier, high liquidity may come at the sets do not generate much profit.

Ted Baker appear to be very liq-

current ratios are less than 1.0.

cost of profitability, as liquid as-

Figure 64. Management Efficiency

to inefficient management of the

12 10 8 6 4 2 0

inventories. Debenhams inventostable in the past five years and

ry turnover ratio had remained furthermore, it is evident that in this ratio not too high or too low.

comparison to its competitors,

2008 6.62 11.32 4.01 2.03

2009 6.49 11.10 4.50 1.90

2010 6.46 10.30 4.96 1.80

2011 6.21 9.27 4.72 1.89

2012 5.90 9.04 4.41 1.77

Debenhams M&S N Brown Group Ted Baker 6 5 4 3 2 1 0 Debenhams M&S N Brown Group Ted Baker x

Figure 65. Liquidity

2008 0.54 0.59 4.34 2.24

2009 0.88 0.60 4.86 1.93

2010 0.41 0.80 4.52 2.36

2011 0.59 0.74 3.35 2.14

2012 0.63 0.73 5.11 1.98

Debenhams plc. Analysts Report 2013 58

Capital Structure For analysing the capital struc-

ture across firms, the gearing ratio had been used. The graph had the most volatile gearing and the N Brown Group had only below indicates that Debenhams ratio, whilst Marks & Spencer fluctuated by a 10 - 12% margin

Figure 66. Capital Structure 100 80 60 40 20 %

in the past five years. Debenhams had the highest gearing ratio in 2008, however, by 2010 it became the least geared company.

2008 87.68 49.65 50.69

2009 61.73 50.21 48.82

2010 7.46 51.03 41.89

2011 27.05 41.81 34.52

2012 27.39 41.21 38.33

Ted Baker has been excluded long-term interest bearing debts. Market Value Ratios

from the analysis, as it has no

Debenhams M&S N Brown Group

Figures 68 and 69 show the price movement of Debenhams in comparison to its peers and the general retail industry. The share price performance of N Brown Group, Debenhams and Marks

Figure 67. Price to Earnings 18 16 14 12 10 8 6 4 2 0 Debenhams M&S N Brown Group Ted Baker 2008 4.63 5.96 9.68 11.11 2009 7.27 6.65 7.29 10.39 2010 7.16 9.46 7.54 13.33 2011 5.33 8.75 9.19 14.71 2012 9.69 10.25 7.51 17.02

and Spencer have been similar in the past five years. Ted Baker the rest of the group in 2012 and on the other hand diverged from its share prices experienced a Figure 68 further shows that Debenhams has consistenlty been able to outprform the general the analysis. retail industry in the five years of

relatively large growth in 2013.

59 Debenhams plc. Analysts Report 2013

The P/E ratio trend shows that

Debenhams price to earnings and 2011; however, this multiple

hams share prices from about

was lower than its peers in 2010 picked up significantly in 2012, following the increase in Deben-

60 pence to over 100 pence per share. Nevertheless, in 2013 the companys P/E ratio of 11.03 has remained consistently below the industry P/E ratio of 15.27.

Figure 68. Debenhams Price Movement In Comparison to FTSE 350 General Retailing (Source: Financial Times, 2013)

Figure 69. Debenhams Price Movement In Comparison to Peers (Source: Financial Times, 2013)

Debenhams plc. Analysts Report 2013 60

3.6 Analysis of the Retail Specific Ratios

The cross-sectional and time-sealso been conducted using retail

Like for Like Sales Figure 71 shows Debenhams trend in like fore likes and unadjusted sales increase in the past and 2009, which may have been

ries analysis of Debenhams has specific ratios. While common fifor understanding the overall

nancial ratios are good measures performance of the company,

due the financial turmoil of 2008.

five years. Like for like shows the growth in sales from one year to the next after excluding the effects of expansions, acquisitions or any other events, which may have resulted in artificially inflated sales. It is evident that the like for like sales of Debenhams and Marks & Spencer have followed a somewhat similar trend. Both compa-

After 2009, they showed signs of growth and by 2012 Debenhams and N brown group reached the It can generally be said that the same level of like for like sales. growth in Debenhams like for

the retail specific ratios attempt which may have not been cap-

to analyse some specific factors tured by the earlier analyses and the retailers.

are important to the survival of Unfortunately, there are a few limitations to this analysis. Some companies do not report many of the items that are needed in calculating these ratios. Hence, at times only two or three compacross-sectional analysis. nies were used in conducting the

likes has had an upward trend. Furthermore, due to the cyclical nature of retailers, this upward

trend is expected to continue since the UK economy is on the verge of recovery.

nies had negative trends in 2008

Figure 70. Like for Like Sales %

15 10 5 0

-10 Debenhams M&S N Brown Group

-5 2008 -0.9 -0.5 12.5 2009 -3.6 -5.9 10.7 2010 0 0.9 3.3 2011 -0.3 2.9 1.3 2012 1.6 0.3 1.6

61 Debenhams plc. Analysts Report 2013

Figure 71. Sales Growth % 8 6 4 -2 -4 -6 2008 2009 2010 2011 2012 2 0 Unadjusted Growth Like for Likes

Gross Margin Return on Inventory This ratio shows the average reover its cost. A ratio of more than

12 10

turn generated by the inventory 1.0 is an indication that the comthan its cost. It is evident that

pany is selling its inventory more Debenhams G.M.R.O.I has been

below 1.0 in 2011 and 2012 and in the the past five years it has never been significantly above

8 7 6 5 4 3 2 1 0 Debenhams M&S N Brown Group Ted Baker 2008 1.13 7.13 4.96 2.82 2009 1.04 6.58 5.11 2.68 2010 1.03 6.30 5.48 2.82

Figure 72. G.M.R.O.I

1.0. The competitors on the other turns well above the cost of their inventories. Sales per Square Foot This measure shows the managements efficiency in creating revenue for each square foot of the & Spencer retained a stable ratio during the five year period. On

hand were able to generate re-

2011 0.96 5.74 5.51 3.05

2012 0.93 5.49 4.97 2.80

shop floor. Debenhams and Marks

Figure 73. Sales Per Square Foot 100 80 60 40 20 0 2008 171.82 590.74 912.62 2009 173.42 547.94 824.74 2010 170.97 556.36 778.10 2011 177.59 559.81 831.16 2012 178.08 554.26 895.40

the other hand, Ted Bakers trend a U shaped pattern.

in sales per square foot followed

Debenhams M&S N Brown Group

Debenhams plc. Analysts Report 2013 62

3.7 Credit Worthiness and Distress Prediction

There are many reasons as to financing. Companies with high rates of marginal tax find debt are able to deduct the interest as financing very attractive, as they an ordinary business expense. motivates the companys manage-

why firms use debt as a source of

For analysing Debenhams financial health, the Tafflers Z-Score model, a popular model in pre-

weights and the sum of the prod-

ucts of each coefficient with its corresponding variable produces a unique Z value. If the Z-value derived is less than zero, the model predicts financial distress.

dicting financial distress for UK companies, has been used. In this model four variables are assigned

This source of financing further ment to create value for the firm,

Z=3.2+12.18(X 1 )+2.5(X 2 )-10.68(X 3 )+0.0289(X 4 )


which reduces conflicts of interest between the shareholders and managers. (Palepu, Healy, & Peek, 2010) Table 13. Taffler Z-Model Analysis

In order to analyse the credit worportant to evaluate the likelihood

thiness of Debenhams, it is imof this company experiencing financial distress. Analysing the credit worthiness of a company,

simply by relying on a specific model is nave (Palepu, Healy, & Peek, 2010). A thorough analysis companys strategy, accounting

requires the assessment of the policies, financial ratios and some

Table 14. Accuracy of Bankruptcy Models (Source: Fedorova, Gilenko, & Dovzhenko, 2012)

other factors. Nevertheless, these models aid the analysis by giving an overall view on the companys probability of experiencing financial distress.

This ratio is defined as:

63 Debenhams plc. Analysts Report 2013

According to the the analysis in

table 13, the Taffler model pre-

the highest overall efficiency in predicting financial distress and healthy companies. Therefore, there is a higher probability it will is the most accurate in identifying if Debenhams is indeed healthy, be identified by this model. The Fulmer model predicts bankruptcy when H < 0, which is the case

There are many problems assomodels. Firstly, the ratios are

dicts bankruptcy for Debenhams. accurate analysis, a different used. Table 14 shows the accuracy of the forecasts of different

ciated with using the bankruptcy often calculated using historical information, which in case of Deannual report as the latest data with the most recent data, there benhams is represented by 2012 have not been released yet. Even is no theoretical explanation for justifying the use of these models and, therefore, there is no evidence that these models have been specified correctly. Moreover, the model only predicts two scenarios of bankrupt or no bankIt is also important to point out

However, in order to have a more bankruptcy model has also been

bankruptcy models across 3,505 medium-sized Russian enterprisFulmers model appears to have es (Fedarova et al, 2012). The

for Debenhams. Both Bankruptcy model have predicted financial distress for Debenhams.

H=5.528(V 1 )+0.212(V 2 )+0.073(V 3 )+1.27(V 4 )-0.120(V 5 ) +2.335(V 6 )+0.575(V 7 )+1.083(V 8 )+0.894(V 9 )-6.075

ruptcy, which is rather simplistic. that these models predict bank-

Table 15. Fulmer H-Model Analysis

ruptcy one year in advance. It has been over ten months since the release of the annual reports and ating normally. the company appears to be oper-

Debenhams plc. Analysts Report 2013 64

3.8 Economic Value Added

Calculating NOPAT EVA was developed in 1982 by Joel Stern and G. Bennett Stewart profit, as opposed to the acThere are two different methods The Net Operating Profit after tax

the corporate advisory firm of III as a measure of the economic counting profit of an entity. The difference between this method of measurement and some tra-

of defining the EVA namley the

accoutning and the finance ones. This section concentrates on evaluating Debenhams EVA by The accounting measure of EVA is calculated as the Net Operating average cost of capital.

shows the ability of a company company in not geared. In deriv-

in generating earnings when the ing at NOPAT, certain adjustments

using the acounting definition.

were made to the earnings before to obtain a more accurate figure. These adjustment were made as shown in table 16.

interest and tax (EBIT) in order

ditional methods of measuring profit is that EVA determines the net of both the direct cost of debt capital and the indirect cost of equity capital. (Grant, 2003) residual income of the company

Profit After Tax less the weighted

EVA=NOPAT- Cost of Capital


Table 16. NOPAT Calculations

65 Debenhams plc. Analysts Report 2013

Calculations are shown in the appendix

Cost of Capital Since Debenhams does not isweighted average cost of capital relationship:

EVA Calculations The table and the bar chart below been conducted in deriving the

sue any preferred shares, the is calculated by using the below

show the trend of Debenhams EVA measure in the past five years. As it can be seen, in the

cost of equity and the weighted average cost of capital required certain made. Furthermore, relying on assumptions to be


V .k .(1-)+EV .k

years of the analysis, Debenhams has been able to generate economic profit. Limitations in Deriving EVA It is important to note that many


the standard form of the CAPM

model is rather limited as this model makes many assumptions in measuring the cost of equity. In order to assess the accuracy of the results sensitivity analysis needs to be conducted.

D = Market value of Debt8 E = Market value of Equity (Annual Market Capitalization) V = Total Market Value (D+E) Kd = Cost of Debt9 Ke = Cost of Equity = Corporate tax rate

of the calculations, which had

Table 17. EVA Calculations The cost of equity of the company low equation: has been calculated using the be-

k e=r f+[(r m-r f )+CRP)] (5)

Rf = risk free rate (10 year UK government bond yields) = systematic risk (Retrieved from Financial Times) Rm = Return on the market10 CRP = UKs average country risk premium

Debenhams does not issue any bonds. So the Market value of the companys loans had to be calculated by a specific relationship, which has been shown in the appendices.

Figure 74. EVA

160 120 80 40 0 2008 2009 2010 2011 2012

9 Cost of Debt has been estimated by taking the weighted average of the companys interest rates. The calculations have been shown in the appendices. 10

The return on the market has been calculated for each year, by taking the geometric average return of the previous 11 years of the FTSE 250 Index. A big sample size was needed for each years calculation in order to get a positive value for this variable.

Debenhams plc. Analysts Report 2013 66

67 Debenhams plc. Analysts Report 2013

4.1 Introduction


The aim of this section is the val-

uation of the companys equity. Pinto et al (2010) defined the five necessary steps in valuing a comunderstanding the nature of the

panys stock. These steps are the business, forecasting companys earnings, selecting the appropriate valuation model, converting forecasts to a valuation and final-

ly applying the valuation concluhas already been extensively an-

sions. The strategy of Debenhams alysed in the corporate strategy section of the report. Therefore, at taking the steps remaining in valuing the companys equity. this section of the project aims

Debenhams plc. Analysts Report 2013 68

4.2 Forecasting Earnings

In this section of the report, De-

benhams future earnings have methodologies. The purpose of forecasting the future earnings is so that the obtained results can

Data Collection and Trend analysis Data collection The Earnings data for Debenhams has been captured from DATASTREAM for the past ten years, as Furthermore, some of the issues encountered in the data selection process were as follows: The authors initial intent

been forecasted using various

later be used in the valuation of

the companys equity. The most effective way by which forecasts are conducted combines quantigood judgement based on past tative forecasting methods, with experiences. It is important to avoid the total reliance on either ods (Reitsch, 1998). In general, quantitative or judgmental methanalysts reliance on data manipgreater, as the publicly available

shown in table 18. The author has deliberately chosen this number of observations for a number of reasons. Firstly, choosing a long-

was to use quarterly earnings for conducting the analysis. This was with the aim of having a larger sample data and

term horizon, one that spans over several decades, requires the use of judgmental forecasting

methods. According to Reitsch (1998) Quantitative forecasting techniques such as the moving

performing a more accurate analysis. However, quarterly Debenhams and the author reports. reports were not released by had limited access to interim Finally, due to the unavail-

ulation techniques tends to be information regarding the companys overall performance may be rather biased and therefore, not a reliable benchmark for judging the companys future profitability.

averages, exponential smoothing

and Box-Jenkins methodologies are not good predictors of the economic turning points and long time-horizons.

their use is not appropriate for the authors aim was to incorporate enough observations in the could have been identified. analysis so that trends in the data Secondly,

ability of financial reports prior to 2006, adjustments for non-recurring expenses past five years.

have only been made for the

Table 18. Debenhams Historical Earnings Year 2003 108.4 2004 -28.3 2005 64.3 2006 43.7 2007 79 2008 77.1 2009 95.1 2010 102.1 2011 117.2 2012 125.3

Net Profit

69 Debenhams plc. Analysts Report 2013

Trend Analysis A quick glance at figure 75 indicates a rapid drop in earnings in 2004, which was later followed by an upward trend. However, the visual interpretation of this Figure 75

graph is of little value in correctly which is often used in examining

identifying patterns. A method, data patterns, is the autocorrela-

tion analysis. Time-series data is frequently correlated with itself when lagged one or more periods, hence, autocorrelation analysis is a useful tool for examining this data (Reitsch, 1998).

The appropriate number of time

Figure 76

lags for conducting this analysis observations. Hence, in this case, ducing a correlogram. This graph

is N/4, where N is the number of three time lags were used for proreveals that the correlation coefclose to zero. Furthermore, the t-statistics obtained by Minitab

ficients of the three time lags are

for each correlation coefficient suggests that none of the coefficients are significantly different

from zero. According to these results, the autocorrelation anal-

Debenhams plc. Analysts Report 2013 70

ysis suggests that the data is random. However, by looking at the time-series analysis an upward It may be that the results from

Figure 77

trend can clearly be observed. correlogram are not statistically significant due to the small sample size.

Another method of analysing the data is by using Minitabs Trend Analysis function. This function attempts to describe the trend

in the time-series by the means of least squares method. This is a fits the observations is computhas confirmed the existence of an method by which, a line that best ed. The trend analysis function upward trend in the time-series. This is consistent with the earlier visual interpretations. However,

Figure 78

note that the MAPE is 41.94%, which is a quite large percentage may not be statistically significant. error; hence, the trend identified

71 Debenhams plc. Analysts Report 2013

In order to explain Minitabs results in a more formal manner, the findings of the trend analysis function have been replicated by conducting regression analysis. against time and find a line function in the form of:

least squares measure in computing the fitted line. As it can fitted line is: be seen the equation of the best

38% of the changes in earnings time.

are explained by the variations in Thus, it can be concluded that

The aim is to regress earnings

=27.99+9.163t (7)

the results of the autocorrelation analysis is consistent with the lack of explanatory power of the OLS regression. Thus, even upward trend in the data, the though there appears to be an statistical measures indicate that

A snapshot of the regression analysis from Minitab is shown in table 19. By looking at the

=b 0+bt (6)

Figure 78 shows the fitted line the regression analysis. The OLS plot is similar to that of the Trend Analysis as both models use the

students t-table at 8 degrees of freedom it can be seen that at 10% level of significance, the slope coefficient is significantly different from zero. Furthermore,

plot, which has been obtained by

the data is random and this trend is not statistically significant.

the R2 measure shows that only

Table 19. Regression Analysis

Debenhams plc. Analysts Report 2013 72

Forecasting Methodologies OLS Method One method of forecasting the earnings is by using the OLS method. The regression analysis for Debenhams earnings has already part. Hence, all is needed is to plug the numbers 11, 12 and 13 in the been conducted in the previous Moving Averages Moving averages is a forecasting of earnings are averaged and Generally this model gives more accurate results when it is used on stationary data. However, when

method by which a specified set used in forecasting the future period profits. The assumption is that the past fluctuations in the earnings are due to random

the Augmented Dickey Fuller test (ADF) was conducted in Stata, it was shown that both the original

equation to obtain the forecasts

for the years 2013 to 2015. Fortunately the Trend Analysis function in Minitab is capable of making this calculation. The results are shown in the table 20.

departures from a smooth earn-

data and the first differences are non-stationary. Nevertheless, this model has been used in forecasting Debenhams earnings, as it has been suggested that it yields better results than the simple average forecasting models. (Reitsch, 1998)

ings curve. Hence, the averaging out the past fluctuations and aids 1998).

of past observations smoothens short term forecasting (Reitsch,

Figure 79

Table 20. OLS Forecast Results Year 2013 2014 2015 Forecasted Earnings (m) 128.79 137.95 147.11

Figure 80

Table 21. MA Forecast Results Year 2013 2014 2015 Forecasted Earnings (m) 103.36 108.61 111.31

73 Debenhams plc. Analysts Report 2013

Random Walk Model It is important to note that the Many empirical researches have shown that the earnings of a company exhibit a random walk or random walk with a drift behaviour. According to this model, the best benchmark for forecasting same, with its variance increasfollow a random walk with a drift, then the relationship is as follows:

moving averages only take into account the earnings in the past n periods. Hence, choosing a smaller number of periods means that more weight has been put on the most recent periods. In order to put more emphasize on the recent years only 5 earnings data of observations to be averaged. have been chosen as the number As shown in figure 80, Minitab is capable of performing Moving averages forecasts. This graph only

ing as t increases. If the earnings

E (t+1)=d+E t+u t (9)

the future earnings of a company

is its prior years earnings. A study suggested that in comparison to the simple random walk model of

In this case, the d term is the drift + td and var(Et) = t2. in the model. Therefore E(Et+1) = Et

forecasting earnings, the forecasts conducted by professional analysts are only 22% more accurate. (Palepu et al, 2010) The Simple Random Walk model is mathematically expressed as follows:

The initial trend analysis indicated that there is an upwards trend in the time-series. Therefore, in conducting the forecast using the random walk model, it is important to

shows the forecasted earnings of Minitab, forecasts for the years tering the forecasted value for

2013. Due to the limitations of 2014 had to be made by re-en2013 back into the time-series and then re-running the function. The same process had to be done shown in table 21. for 2015. The results have been

include the drift term to the model. taking the average of the first dif-

This drift term can be calculated by ferences of the time-series. Table 21 shows that the mean of the first formation the forecast of the years mula 9. Furthermore the standard deviation can be measured by the relationship sqrt(t)*. differences is 1.88. Using this in2013 to 2015 can be made by for-

E (t+1)=E t+u t (8)

has mean of zero and variance var(Et) = t2. Thus, it can be said of 2. Therefore, E(Et+1) = Et and

The term ui is a noise term, which

that the mean of the random walk

process is expected to remain the

Table 22. Descriptive Statistics

Table 23. Random Walk Forecast Results Year 2013 2014 2015 Forecasted Earnings (m) 127.18 129.06 130.94

Debenhams plc. Analysts Report 2013 74

Segmental Forecasting Another method of forecasting takes advantage of the compaAlthough Debenhams has reStatistics section of the report.

the future earnings of Debenhams nys segmental information. The forecast of the future earnings analysing its segmental perforof a company is often aided by mance, or as Arnold and Moizer (1984) highlighted, by utilizing a break-down-and-build-up ap-

ported its sales for each segment, there are no records of the companys segmental earnings. Hence, a specific model that forecasts earnings based on the regional sales and the consolidated net profit has been used in

The geometric average of the growth of the segments has been used as the expected segmental

growth element of this model. earnings for 2013.

Table 24 shows the forecasted The segmental forecast has only been made for the year 2013. The author attempted to forecast assuming that the sales growth,

this section. This model, which (1980) is as follow as shown in fromula 10. The expected segmental growth

proach. Furthermore, in a study

had been introduced by Roberts

conducted by Kochanek (1974), he observed that the stronger the a company, the more accurate the that company. segmental reporting practices of forecast of the future earnings of

for the years 2014 and 2015 by level of sales and segmental sales

is calculated based on the growth

in sales in the previous years. The growth in sales for the segments were shown earlier in the Basic

are fixed. However, these are very unrealistic assumptions as they would imply that the net profit while it sales is never changed.

margin of the company increases

E(X t+1seg)=


)].S j,t.( j,t+1

seg seg

Xt S tcons


) (10)

cons E(X(t+1) seg) is one year ahead forecast of consolidated earnings,and seg refers to the use of geographical segment information.

St cons is consolidated sales in period t.

seg Sj,t is sales in period t for segment j.

Xtcons is consolidated earnings in period t.

seg E(GWTHj,t+1 ) is the expected growth from period t to t+1 for segment j.

Table 24. Segmental Forecast Results Segments UK Ireland Denmark Rest of the World Consolidated Earnings Expected growth 3.24% -5.53% 17.36% 12.57% Consolidates Sales, m 2229.8 2229.8 2229.8 2229.8 Consolidated Earnings, m 125.3 125.3 125.3 125.3 Segmental Sales, m 1860.3 136.5 142.7 90.3 Segmental Earnings Forecast , m 107.92 7.25 9.41 5.71 130.29

75 Debenhams plc. Analysts Report 2013

Comparing Forecasting Results In forecasting Debenhams earnings different of a long time-span of ten years method Makridakis and Winkler (1983) stated: In an extensive study of the ods, Makridakis et al., (1982, 1983) found that a simple average and a weighted average of forecasts from six methods outperformed virtually all or perhaps even all of the individual methods, including the six methods being combined as well as the other sixteen individual methods included in the study Thus a single forecast was produced by averaging the results of all methodologies.

were used, which gave various results (see fig. 81). The high MAPEs that were often shown on the graphs were indications that these forecasting results are far from accurate. The lack of data availability (i.e. quarterof more advanced forecastingly earnings) prevented the use ing methodologies such as the quarterly data would have been using smoothing and averaging


in conducting the analysis may have prevented obtaining more accurate forecast results, as the economic cycles may have dis-

accuracy of forecasting meth-

torted the data and resulted in a five years of quarterly data would viding a larger sample size within a shorter time-span. The data obtained for conducting

shift in the time-series. Access to have resolved this issue by pro-

Box-Jenkins technique. The use of more appropriate for forecasting techniques, as these models smoothen the seasonality effect embedded in monthly and quarterly data.

this analysis was actual data from

Debenhams income statements,

which shows that such issues are faced by analysts on a day to day basis. With regards to identifying the most accurate forecasting

Figure 81

Another issue concerns the actual nature of the data. The ADF test conducted on Debenhams earnings showed both the origiwere non-stationary. The mov-

nal data and the first differences ing averages methodology gives more accurate results when used on stationary data. Also the use Table 25. Average of Forecast Results (in m) 2013 2014 2015 OLS 128.79 137.95 147.11 Moving Averages 103.36 108.61 111.31 Random Walk 127.18 129.06 130.94 Segmental 130.29 N/A N/A Average 122.41 125.21 129.79

Debenhams plc. Analysts Report 2013 76

4.3 Equity Valuation

A crucial assumption that needs to be made in the valuation of a companys equity is that the infrom its market price. The intrinsic value of the assets assumes that the investment characteris-

Equity Valuation Using Appropriate Models The going-concern valuation The relative valuation models on the other hand estimate an assets value relative to another

trinsic value of the equity differs

models are divided in to two

groups as shown in figure 82. attempt to estimate the intrinsic mates can then be compared with

The absolute valuation models value of the equity. These estithe actual stock prices to judge Absolute valuation models usu-

asset (Pinto et al, 2010). These methods of valuation, which are also referred to as the market

tics of those assets are clearly un-

derstood. Therefore, the intrinsic values that are often calculated by investors reflect their views et al, 2010). on the stocks actual worth (Pinto Another assumption that has Debenhams equity is the going-concern assumption. Earlier,

based valuation models, often

whether the stock is fairly priced. ally discount the expected future cash flows of the company in companys stock. Models such as order to estimate the value of the the dividend discount model, free cash flow model and the residual (Pinto et al, 2010). income fall within this category

use price multiples such as the value multiples also fall within this category.

PE, PCF, PS and PB. Enterprise

been made in the valuation of

In this section some of the popbeen introduced and where it

ular valuation techniques have was appropriate, they had been used in the valuation of the Debenhams equity.

in the bankruptcy studies, it was shown that two different models predicted financial distress for Debenhams. However, the UK economy has shown signs of recovery in the recent quarters; furthermore, the ratio analysis indicated that the companys performance has been more on the positive side in the past few years. As a result the author has

Figure 82. Going-Concern Valuation Techniques

Going-concern Valuation

made the going-concern assumption and has used the going-concern valuation techniques.

Relative Valuation Models

Absolute Valuation Models

77 Debenhams plc. Analysts Report 2013

Relative Valuation of Debenhams Price multiples are popular ratios panys stock. The main reason unsimplicity. Using price multiples, There are limitations to the PE ratio, as the earnings of a company can be volatile or even at times industry average. Furthermore, a

for assessing the value of a comderlying their popularity is their allows investors to determine whether a companys stock is fairly valued. In studies conduct-

significantly Lower price to cash better at generating cash flow than the average industry.

negative. Therefore, other multiples such as Price-to-cash flow calculated in this section11. and price-to-sales have also been Debenhams price multiples have in table 27 along with the average evident that the price multiples

flow implies that Debenhams is

The industrys multiples can

ed by Arnold and Moizer (1984), scholars, it was shown that the PE ratio is one of the most impor-

be regarded as a standard for calculating Debenhams current fair value. This is done simply by multiplying the industry price multiples by Debenhams fundamentals.

Barker (1999) and a few other

been calculated as demonstarted multiples of the industry. It is of Debenhams are lower than the

tant methods of valuing a compathat in general analysts prefer the

nys stock. Barker (1999) showed use of the P/E ratio over P/CF as the accrual information of the companies provides them with valuable knowledge. The trailing P/E ratio is calculated simply by

Table 26. The Derivation of Per Share Fundamentals Net profit Sales Cash Flow Shares outstanding Earnings per share (EPS) Sales per share Cash flow per share12 Current price 125.30m 2,229.8m 201.50m 1281.3m 9.80p 174p 15.73p 108.10p

dividing the current stock price by the last years earnings. Some P/E ratio, which is calculated by by the forecasted earnings. websites also report the forward dividing the current stock price

Table 27. Debenhams and Industry Price Multiples Price Multiplies P/E P/S P/CF Debenhams 11.03 0.62 6.87 Industry Average 15.27 1.65 23.15

11 The author initially calculated the price to book value. However, in the process of adjusting the book value for intangible assets, it was realised that the book value net of intangible assets is negative. This is because the company had a net assets of 661m and intangible assets of 864.9m. 12

This figure only includes the operating cash flows.

Debenhams plc. Analysts Report 2013 78

Dividend Discount Model As it can be seen the fair value The dividend discount model is one of the simplest discounting cash flow methods for measuring the intrinsic value of a companys stock. A survey conducted by discount model is generally not considered a suitable valuation technique for companies that pay this case the author believes that this model is suitable for valuing dividend payments and the level are shown in table 29. It is be-

of Debenhams equity has been estimated to be much higher than the current stock price. According to this model, the stock price is undervalued. Finally, the share price of Debenhams in 2014 can

unstable dividends. However, in

Block (1999) indicated that 42% of the respondents considered important for valuing the equity referring back to the ratio analthe dividend discount model very of the individual companies. By ysis section of the report, it can volatile dividend yields in the (11)

also be calculated by multiplying

Debenhams stock. Debenhams of companys retained earnings lieved that following the financial

the industry average of the P/E in the previous section. It is im-

ratio by the earnings forecasted portant to note that in doing so the industry P/E ratio is assumed to remain stable. In other words, assume:

be observed that Debenhams had years of the analysis. The dividend

turmoil of 2008, Debenhams de-

creased and eventually stopped levels of negative retained earn-

paying dividends due to its high

( P/E )


( P/E ) )


P 2014= (


2013 =15.27 9.6p 13 = 146.59p (12)

Table 28. Valuation By Comparables Multiplies P/E P/S P/CF Industry 15.27 1.65 23.15 Fundamentals EPS Sales per share Cash flow Debenhams 9.8p 174p 15.73p Fair value 149.65p 287.1p 364.15 266.97


Table 29. Trend in Debenhams dividends and Retained Earnings 2008 Dividend per share (in pence) Retained earnings (m) 5.16 -574.6 2009 0.25 -546.6 2010 0 -176.2 2011 1 -15.1 2012 3 -9.9

79 Debenhams plc. Analysts Report 2013

13 The weighted average number of shares outstanding has been assumed to remain the same in converting forecasted net profit to EPS.

ing, in an attempt to recover it.

The considerable improvement ings appears to be correlated

However, after 2013 the company is expected to grow at a sustainable rate of 2.4%. This sustainable

The stock price of Debenhams on the 3rd of September 2012 was 97.95 pence, which implies that

in the companys retained earnwith the increased levels of div-

growth rate has been derived the UK GDP growth in the years 2015 to 2019. Hence, for valuing

idend payments. According to the report the UK economy has shown signs of recovery and although the retail industry growth has been slow, the governments

based on PwCs projections of

Debenhams stock at that time was undervalued. Furthermore, comparing this result with the still shows that Debenhams stock is undervalued. Therefore the dividend discount valuation the relative valuation techniques.

the corporate strategy section of

Debenhams stock the two-stage

current stock price of 108.10p

dividend discount model has already been calculated for measuring the EVA and is estimated to be 6.47%. The two-stage model is as follows:

been used. The cost of equity has

expansionary policies are expect-

results reaffirm the findings of

ed to favour this industry. Therefore, the author believes that by recover its retained earnings and payments are expected to grow to its previous level in 2008. In other words: 2013 Debenhams will be able to as a result, Debenhams dividend

V 0=

(1+g ) D(1+r) +
0 t=1 s t t

D 0 (1+g s ) t (1+g L ) (15) (1+r) n(r-g L )

V 2012=

5.16 5.28 + = 119.4p 1.0674 1.0674 x 0.0434

E(D 2013 )=D 2008 g s=


Before making any conclusions,

E(D 2013 ) 5.16 -1= -1=72% D 2012 3


it is important to note that this on fundamentals retrieved from fore, unlike the relative valuation

estimated intrinsic value is based the 2012 financial reports. Theremodels, the intrinsic value needs to be compared with the market price at the date when the finan-

cial reports were first published.

Debenhams plc. Analysts Report 2013 80

Residual Income Model The residual income model is another technique for calculating the intrinsic value of Debenhams stock. A company that is able to earn profits higher than its total For valuing Debenhams equity, to justify that the ROE will indeed decrease. Firstly, for converting the forecasted net profit to EPS, it will be assumed that the number of shares outstanding will re-

the multi-stage residual income model was chosen. As it was shown earlier in the ratio analysis section, Debenhams had which over time faded to only

cost of raising capital is generating economic profit and creating value. The economic value added that was calculated for Debenhams in the financial analysis section showed that in the past five years Debenhams has been able to generate and sustain a consistent flow of economic profit. Thus, all else equal, higher (lower) residual income should be associated with higher (lower) valuations (Pinto, 2010). The residual income valuation

high ROE of about 60% in 2008, 20%. Based on the forecasts, it is decrease. Having already calculat-

main unchanged in the next two years. Thus, the foreccasted EPS for 2013 and 2014 are a shown in table 31. For measuring the 2013 and 2014, the clear surplus relationship is as follows:

believed that the ROE will further ed the forecasted dividends and

book value of equity for the years relationship had been used. This

earnings for 2013 and 2014, the

book value of Debenhams equity

can be measured for these years

B t=B (t-1)+E t-D t


Table 30. The Forecasted Return On Equity 2013 Earnings per share Book value per share Return on equity Forecasted Net Profit Shares Outstanding EPS 9.56p 55.99p 17.07% 2013 122.41m 1,281.3m 9.56p 2014 9.77p 60.18p 16.23% 2014 125.21 1,281.3m 9.77p

model measures the value of the companys equity, by adding its current book value to the total

Table 31. The Forecasted EPS

present value of expected future residual incomes. In mathematifollows: cal terms, this can be defined as

V 0=B 0 +


RI t = B0 + (1+r) t t=1

E t-rB t-1 (1+r) t


81 Debenhams plc. Analysts Report 2013

Once these figures have been estimated, Debenhams forecasted shown in table 30. It is expected Return on Equity is derived as that by 2014 the ROE decrease to

However, this is the value of De-

benhams stock in 2014. The rewill be calculated by the relationship 19.

sidual income for 2013 and 2014

about 16%, which is close to the retail industry average of 15.44%. be assumed that the ROE will remain stable, at a rate equivalent Therefore, after this year it can

RI t=E t-rB (t-1) (19)

Table 32. Debenhams Residual Income 2013 Residual Income 6.08 2014 6.00

to that of the UKs retail industry. average. The value of Debenhams relationship below: stock in 2014 can be calculated by

V 2014= B 2014 +

ROE - r 0.1544 - 0.674 B 2014 = 60.48 + 60.48 = 181.87p (18) r-g 0.0674 - 0.024
Finally, the value of Debenhams equity in 2012 can be calculated

V 0=B 0 +


(20) RI t PT - BT 0.08 6 181.87 - 60.18 + = 51.59 + + + = 169.56p (1+r) t (1+r) T 1.0674 (1.0674) 2 (1.0674) 2 Both the DDM and the residual income should theoretically yield the same results. However, even and cost of equity were used in this section and the book values though the same growth rate valuation obtained. So far all the models which have been used in valuing Debenhams equity suggested are under-valued. In order to an-

by relationship 20.


that the Debenhams share prices alyse how sensitive the elements sensitivity analysis has been conducted in the next section.

were calculated using the dividends that had been forecasted in DDM, different results were

in these models are to variations,

Debenhams plc. Analysts Report 2013 82

Table 33. Variations in RI Models Parameters Sensitivity Analysis As it was shown earlier, different Variations in the Parameters Parameters Earnings per share in 2013 Earnings per share in 2014 Expected Dividends in 2013 Expected dividends in 2014 Risk free rate Market return Beta Country risk premium Sustainable growth rate Sustainable return on equity -20% 7.65 7.82 4.13 4.22 1.52% 3.49% 1.18 0.66% 1.92% 12.35% Original 9.56 9.77 5.16 5.28 1.90% 4.36% 1.47 0.83% 2.40% 15.44% +20% 11.47 11.72 6.19 6.34 2.28% 5.23% 1.76 1.00% 2.88% 18.53%

results were obtained by the re-

sidual income and the dividend discount models. However, it is important to note that in deriving many of the elements used in

these models assumptions had

to be made. Therefore, in this section of the report sensitivity show the extent to which the reelements are altered. analysis will be performed to sults would be different, if these Residual Income Model As it can be seen, the highest elasticities are for the sustainable growth rate and the market

Table 34. Valuation Results From Varying RI Models Parameters Equity Value Parameters Earnings per share in 2013 Earnings per share in 2014 Expected Dividends in 2013 Expected dividends in 2014 Risk free rate Market return Beta Country risk premium Sustainable growth rate Sustainable return on equity -20% 164.39 164.4 171.32 171.42 162.72 242.00 219.27 179.88 158.94 131.76 Original 169.56 169.56 169.56 169.56 169.56 169.56 169.56 169.56 169.56 169.56 +20% 174.73 174.72 167.8 167.7 177.00 130.10 138.01 160.34 182.82 207.37

return. However, variation in these parameters did not result into a change in the investment

Table 35. The Elasticity of Parameters in RI Model Elasticities Parameters Earnings per share in 2013 Earnings per share in 2014 Expected Dividends in 2013 Expected dividends in 2014 Risk free rate Market return Beta Country risk premium Sustainable growth rate Sustainable return on equity

decision. Even with +/-20% variations in the parameters, Debenhams is undervalued.

0.15 0.15 -0.05 -0.05 0.22 -1.16 -0.93 -0.27 0.39 1.11

83 Debenhams plc. Analysts Report 2013

Table 36. Variations in DDMs Parameter Dividend Discount Model From table 37 it is evident that Variations in the Parameters Parameters Short term growth Risk free rate Market return Beta Country risk premium Sustainable growth rate -20% 57.60% 1.52% 3.49% 1.18 0.66% 1.92% Original 72% 1.90% 4.36% 1.47 0.83% 2.40% +20% 86.40% 2.28% 5.23% 1.764 1.00% 2.88%

an increase in the market return

or the Beta by 20% would cause to fall below Debenhams share 2013. This would lead to a change in the investment recommendation.

the intrinsic value of Debenhams price on the 3rd of September

Table 37. Valuation Results From Varying DDMs Parameters Equity Value Parameters Short term growth Risk free rate Market return Beta Country risk premium Sustainable growth rate -20% 109.84 114.69 169.34 153.57 126.47 107.54 Original 119.40 119.40 119.40 119.40 119.40 119.40 +20% 128.96 124.51 92.24 97.69 113.06 134.21

Table 38. The Elasticity of Parameters in DDM Model Elasticities Parameters Short term growth Risk free rate Market return Beta Country risk premium Sustainable growth rate

0.40 0.21 -1.14 -0.91 -0.27 0.62

Debenhams plc. Analysts Report 2013 84

Concluding Remarks

In this report the strategy and financial performance of Debenhams plc was thoroughly

to economies of scale. Particular-

ly, the decreased growth in the prior years may be a signal that

the level of Debenhams gearing

analysed and the value of the The analysis of Debenhams strat-

street sales of UK retailers in the opening new stores would lead

and financing costs, which led to the upward trend of the firms net profit margin. However, the oper-

companys stock was estimated. egy showed that Debenhams is increasing the number of its UK

to increased costs, which may icantly higher sales. Nevertheless, the bullish forecasts of the economys growth along with not get compensated by signif-

ating profit margin continues to poor management of operating of the companys retained earn-

decline, which is an indication of costs. Furthermore, the recovery ings from about -550m to -9m

heavily investing in e-commerce, stores and opening franchises in

emerging markets. Considering the rapid growth in e-commerce sales in recent years, the companys viable in multi-channel is seen as a strategy. increased investments

the increased momentum of the consumer confidence may all be indications that such a strategy in the long-run.

retail industry and the improved

in the past five years resulted in in 2010 and the rapid growth of

initiation of dividend payments dividend pay-outs in 2011 and 2012. On the lower end of the scale, the companys low liquidity and bearish bankruptcy scores

the growth in the sales of Deben-


may indeed benefit Debenhams The financial analysis of Deben-

hams rest of the world segment is an indication that Debenhams may benefit from investing in brand internationally. On the new markets and expanding its other hand there have been some debates as to whether expansion within the UK market would lead

hams indicated that this company has been able to increase its net profits in the years of the analysis, and the majority of the companys ratios showed opti-

all indicate that Debenhams may experience financial distress in the case of a market downturn. Furthermore, the companys

assets include high amounts of threat should they require writing down.

mistic trends. Some highlights are the substantial decrease in

intangibles, which pose a serious

85 Debenhams plc. Analysts Report 2013

The forecast of Debenhams earnings showed that the companys net profit is expected to drop in been based on statistical mod-

the intrinsic valuation techniques gave different results, which is tions that were made on the commost likely due to the assumppanys ROE in using the residual

2013; however, this forecast has els that only take historical data

into consideration. Hence, total reliance on this data is somewhat sales of the UK retailers in the forecast and lead to the growth of Debenhams earnings this year. naive. For instance, the increased summer of 2013 may break this

income model. Therefore, in deDebenhams in 2013 the average was used (see table 39).

riving the target market price of of the two valuation techniques A positive economic outlook, un-

dervalued share prices, historical improvements in the companys ratios and fundamentals and low ket participants all suggest that purchased. Figure 83. Debenhams Short-Selling Activity

The valuation of Debenhams

stock using both the relative and

intrinsic valuation techniques showed that Debenhams stock is undervalued. As discussed earlier

level of short selling by the marDebenhams shares should be

Table 39. Calculation of the Target Price Dividend Discount Model 119.40 Residual Income Model 169.56 Average 144.48

Debenhams plc. Analysts Report 2013 86

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Loveless, H., & Craven, N. (2013, March 09). Debenhams Joins The Big Squeeze As Retailers Force Cuts and Payment Delays On Suppliers. Retrieved August 20, 2013, from This is Money: MacDonald, G. (2011, September 5). Debenhams Claims Retail World-First With Smartphone Innovation. Retrieved July 15, 2013, from Retail Week: http:// Marks & Spencer plc. (2008-2012). Annual Reports and Financial Statements. Marsh. (2013). Political Risk 2013. Retrieved August 16, 2013, from Marh: http://usa. McDonald, M., & Christopher, M. (2003). Marketing: A Complete Guide. New York: PALGRAVE MACMILLAN. Mead, N. (2013, January 9). Global Political Risk Atlas 2013. Retrieved August 18, 2013, from The Guardian. Melville, T. (2013, July 31). UK Consumer Confidence Least Bleak Since Early 2010. Retrieved August 3, 2013, from Reuters: N Brown Group plc. (2008-2012). Annual Reports and Accounts. ONS, OECD. (2009). UK population data: how fast is it increasing? Retrieved July 1, 2013, from The Guardian: Palepu, K. G., Healy, P. M., & Peek, E. (2010). Business Analysis and Valuation: IFRS edition (2nd ed.). Andover: South-Western Cengage Learnings. Payne, A. (2012, October 25). The Innovation Struggle: Delivering Disruptive Technologies in Large Organisations. Retrieved August 04, 2013, from Slideshare: Pinto, J. E., Henry, E., Robinson, T. R., & Stowe, J. D. (2010). Equity Asset Valuation (2nd ed.). New Jersey: John Wiley & Sons, Inc. Porter, M. E. (1980). Competitive Strategy. New York: The Free Press. Price, M. (2013, August 14). Eurozone Comes Out of Recession. Retrieved August 18, 2013, from BBC: PwC. (2013). Global Economy Watch . Retrieved July 19, 2013, from PwC: http://www.


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Debenhams plc. Analysts Report 2013 90


Financial Ratios Profitability Ratios

Return on Capital Employed = Gross Profit Margin = Operating Profit Margin = Net Profit Margin = Return On Equity = Profit Before Interest and Tax Average(Ordinaty Share Capital+Preference Share+Reserves+Debentures) Gross Profit Revenue Operating Profit Revenue Net Profit Revenue Net Income Total Shareholders Equity

Management Efficiency
Inventory Turnover = Asset Turnover = Cost of Sales Average Inventory Sales Total Assets Average Inventory Held Cost of Sales Average Trade Receivables Credit Sales Revenue Average Trade Payables Credit Purchases x 365

Average Inventory Turnover Period =

Trade Receivables Collection Period =

x 365

Trade Payables Settlement Period =

x 365

Cash Conversion Cycle =

Inventory Turnover Period + Trade Receivables Collection Period - Trade Payables Settlement Period

Liquidity Ratios
Current Ratio = Quick Ratio (Acid Test) = Current Assets Current Liabilities Cash+Marketable Securities+Receivables Current Liabilities

91 Debenhams plc. Analysts Report 2013

Cash Ratio =

Cash + Marketable Securitieis Current Liabilities Cash From Operating Activities Interest + Tax Cash From Operating Activities+Interest Received+Dividends Received Interest Cash generated From Operations Current Liabilties

Cash Coverage Ratio =

Interest Coverage Ratio =

Cash Generated From Operations to Maturing Obligations =

Capital Structure and Debt Management

Gearing Ratio = Long Term Debts Share Capital+Reserves+Long Term Debt Profit before Interest and Tax Interest Payable

Interest Coverage Ratio =

Market Value Ratios

Dividend Yield = Dividend per Share (1-Corporate Tax rate) Market Value per Share x 100

Basic Earnings per Share =

Net Profit after Tax and Preferred Dividends Weighted average number of shares outstanding Market Value per Share Earnings per Share

Price to Earnings Ratio =

Retail Specific Ratios

Sales per Square Foot = Revenue Total Floor Space in Square Foot Gross Profit Average Inventory Cost

Gross Margin Return On Inventory =

Three-Step Du-Pont Analysis

Return On Equity = Net Profit Margin Total Asset Turnover Equity Multiplier or


Net Income Revenue

Revenue Total Assets

Total Assets Total Shareholders Equity

Debenhams plc. Analysts Report 2013 92

Weighted Average Cost of Capital Weighted Average Cost of Capital Calculation of the Variables
Cost of Debt = Weighted avearge of the Interest Rates Cost of Equity=r f+[(r m-r f )+CRP]
Where: Risk Free rate = 10 years UK Government Bond Yields retrieved from Bank of Englands Website = Systematic risk obtained from Financial Times Rm = Geometric Average of the Annual Market returns (The average of the 10 years prior to each Year of the analysis) R -R Annual Return on the Market = Holding Period Return = t t-1 R t-1 Country Risk Premium = Retrieved from BBC

Table 40. The Calculation of Cost of Equity

Market Value of Equity = Weighter average Number of Shares Outstanding Current Share price Table 41. The Calculation of Makret Value of Equity

Table 42. The Calculation of the Market Value of Debt

93 Debenhams plc. Analysts Report 2013

14 Since Debenhams did not have any bonds the market value of the debt had to be estimated by converting book value of Debt to Market value of Debt by treating the book value of Debt as one coupon bond.

Weighted Average Cost of Capital

Table 43. The Calculation of WACC

Economic Value Added Calculations Tax Subsidy on Deductible Expenses

Table 44. The Calculation of Tax Subsidy on Deductible Expenses

Accounting Policies
This section outlines the key accounting policies adopted by Debenhams PLC, which have material impacts on the analysis. These are policies such as revenue recognition methods, inventory valuation and method of which include the retail companies of Ted Baker, N Brown Group and Marks & Spencer. deprecation. If appropriate, some of these policies will further be compared with Debenhamss peer group, Debenhamss financial statements have been prepared on a going concern basis, which means that the company operates for the foreseeable future, without the threat of liquidation. Debenhams has adopted the International Financial Reporting Standards (IFRS) including International accounting standards (IAS) and International Financial Reporting Interpretations Committee (IFRIC), in preparing its financial stateThis Act is applicable to the companies which have adopted the standards required for reporting in the EU. companys act 2006, which means fewer adjustments were required for conducting the analysis. ments. The financial statements have further been prepared in accordance with the Company Act 2006. Debenhamss peers all operate on the going concern basis. They have further all adopted the IFRS and the

Debenhams plc. Analysts Report 2013 94

Revenue Recognition
Accrual method of accounting recognizes revenue when it has been earned, and expenses when they have been incurred. Companies can recognize revenue before the delivery, at the time of delivery or after the delivery has taken place. These revenue recognition methods are outlined in the notes to the companies financial statements. Understanding a companys revenue recognition method is very important as they may use particular approaches with the aim of manipulating the financial statements.

Debenhams measures revenue at the fair value of the consideration received or receivable, for the goods and the services it provides in the normal course of the business (Debenhams Annual Report, 2012). Revenue is recognised net of any sales-related taxes (e.g. VAT), customer loyalty schemes and staff discounts. There is a variety of ways by which Debenhams generates its sales. In the notes to the financial statements, Debenhams has outlined the revenue recognition method for each method of sale. As it is evident from the table 45, Debenhams (2012) recognizes the revenue at the time of the delivery. It is also important to note Debenhams (2012) further claims that the total amount of returns is estimated based on the accumulated

that the company has a return policy, which allows its customers to return the items they have purchased. experience of the company. A minor red flag which needs to be brought to the surface is that it appears that

Debenhams recognizes revenue without deducting the expected returns from the sales. The wordings of the notes to the financial statement regarding this matter is rather vague in comparison to that of the peers, which could mean that the company is somewhat aggressive in recognising revenue.

Table 45. Method of Sale Store Sales Revenue Recognition Department store goods and the commission on concession and consignment sales are recognized as revenue, the instance the goods are sold to the customers, regardless of the method of payment.

Internet Sales Gift Card Sales Sales to franchisees

Sales made through the internet are recognized as Revenue the instance the goods have been dispatched to the customers. Sales which have been made by gift cards or gift Vouchers are recognised as revenue, when they have been redeemed.

Revenue from the sales to franchisees is recognised when the goods have been dispatched.

95 Debenhams plc. Analysts Report 2013

Expense Recognition
Depreciation Tangible assets with the exclusion of land are depreciated with the aim of allocating the assets cost over its useful economic life. Debenhams depreciates its property, plant and equipment (PPE) at specific rates as line basis from the point that they were first brought into use. shown in the table below. The depreciation is written off the cost of PPE, less residual value, on a straight Freehold land Freehold buildings Long leasehold land and buildings15 Short leasehold land and buildings Retail fixtures and fittings Office equipment Computer Equipment Vehicles Not depreciated 1% 1% or life of lease if shorter Life of Lease 4% - 25% 10% - 12.5% 12.5% - 33.5% 25% or life of lease

Table 46.

The Cost of the PPE is determined by its purchase price and the cost required for bringing the asset to its working condition. Furthermore, the assets useful economic lives and residual values are estimated at the end of each financial year end. The change in any of the estimates is put into effect prospectively. The depreciation rates above were compared to those reported by Debenhamss peers. They all appear to use similar rates in depreciating similar assets. However, as an example Ted Baker depreciates fixtures and fittings at a rate of 20% - 25%, while Debenhams is using rates which range from 4% to 25%. Once again, profits.

this could be a red flag as the company may be recognizing less depreciation costs and hence report higher Cost of Goods Sold In estimating the cost of goods sold (COGS), Debenhams measures inventory at lower of cost or net realizable value utilizing the retail inventory method. The retail method takes into consideration stock loss or reported by the group. items which were sold below cost. Furthermore, concession inventories are not included in the inventory All Debenhamss peers report inventory at the lower of cost or net realizable value. However, while two of the peers use the retail method for calculating costs, N Brown Group calculates costs on the First-infirst-out basis. In order to make this data comparable to the other three companies, making an adjustment adjustments section.

to the inventory valuation method of this company is necessary. This will be discussed in the accounting

15 Included in both long and short leasehold land and buildings is the landlords fixtures and fittings

Debenhams plc. Analysts Report 2013 96

The Amortization of Goodwill Goodwill by definition is the purchasing price of the companys subsidiaries less the fair value of the ac-

quired subsidiarys net identifiable assets. At Debenhams, Goodwill is not amortised but annual reviews at-

tempt to determine whether it has been impaired. In the case goodwill is indeed impaired, the accumulated losses are deducted. Debenhams goodwill represents the goodwill for a portfolio of sites, which has been allocated to groups of cash generating units (CGUs) split on a regional basis according to the level at which management monitors that goodwill. 2003. This allocation was mainly the result of the acquisition of Debenhams stores by Debenhams plc in December

Table 47.

An impairment review conducted indicated that as at 1 September 2012 no impairment of goodwill was necessary. The Amortization of Other Intangible Assets Debenhams is in possession of some other intangible assets such as Licenses and trademarks, internally generated software and purchased software. These are all recognized on the Balance sheet at cost less the accumulated amortization and any provisions for impairment.

technological feasibility has been established. In this case the expense is capitalised as it is expected to bring future economic benefits.

Software development costs under both the US GAAP and IFRS are treated as expenses unless the products

Debenhams intangible assets include assets in the course of construction, which are primarily web development projects, which include costs needed to bring the assets in to use. The rates at which Debenhamss intangible assets16 are amortised are as shown below: Acquired licenses and trademarks Internally generated software Purchased Software

Table 48.

These amortizations are carried out by writing off the above rates from the cost of the intangible assets, less residual value on a straight line basis from the date that they were brought to use.

Up to 10% 12.5% to 33.3% 12.5% to 33.5%

97 Debenhams plc. Analysts Report 2013

Excluding goodwill

Finance Lease Expenses Finance leases transfer all the risks and rewards of the ownership to the lessee, which in this case is the Deboth a an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments and depreciated over the shorter of the useful economic life or the period lease.

benhams group. According to the IAS 17at the inception of the lease, the finance lease should be recorded as

The lease payments have been apportioned between the finance charges and reduction of the lease obligation with the aim of obtaining a constant interest rate on the remainder of the liability balance. Operating Lease expenses

Any lease, which does not fall into the category of finance lease, is referred to as operating leases. The rental payments net of lease incentives are recorded on the income statement on a straight line basis over the leasing period. Retirement Benefit Costs The Debenhams group operates both a defined contribution plan and a stakeholder scheme. The contri-

bution plan is specific to the countries of Denmark and Republic of Ireland, while the stakeholder scheme income statement when they fall due. The contribution scheme for instance can be identified as employee benefit expense on the income statement. ment of comprehensive income. Debenhams PLC recognizes actuarial gains and losses in full in the period in which they occur in the statePast service costs incurred by Debenhams are immediately recognised in the income statement with the

is aimed at Hong Kong and the UK. The contributions to these schemes are recognized as expenses in the

exception of the situation in which the changes in the pension plans are conditional on the employees tised over the vesting period.

remaining in service for a specific period of time (the vesting period). In this case the services cost is amor-

Debenhams plc. Analysts Report 2013 98

Critical Accounting Estimates Many estimates are made by Debenhams and its peers regarding the future. For instance, as earlier described, the economic useful life and residual value of assets in the calculation of depreciation requires the judgement of the management. However these estimates rarely represent the actual results. Debenhams makes many of these estimates based on the historical accumulated experience of the company17. Furtherfrequently. Debenhams has thus outlined the estimates and judgements, which may have material impact the following cases. more, by analysing historical and expected future events the company analyses the judgements it makes on the future financial statements of the company. Some of these estimates and the judgements are made in Testing goodwill for impairment using the value-in-use method requires the estimates of the future cash flows and the appropriate discount rate for discounting those cash flows. requires annual reviews by the management. The level of vesting for expensing the fair value of share based payments needs to be estimated and Actuaries in measuring the defined benefit obligations employ many assumptions into their calculacosts. These estimates may differ to the actual outcomes. impairment when necessary.

tions such as return on plan assets, discount rates, mortality rates, inflation, future salary and pension Debenhams estimates the useful economic life of PPE at the end of each financial year and assesses for


99 Debenhams plc. Analysts Report 2013

As with the case of estimated number of annual returns