debenhams analyst report

MA International Financial AnalysisDissertation 2013

Financial Analyst’s Report

Kaveh Salehzadeh Nobari070622373

My gratitude goes to all my lecturers for their support throughtout the course. Special thanks to Professor Hussain, Dr. Bathia and Dr. Che who always kindly assisted me with my queries and provided me with sound and thoughtful advices. I am also very grateful of my family and my partner for their constant support and encouragement.

Acknowledgments

The aim of this report is to analyse the past performance and the fu-ture prospects of Debenhams plc in order to provide an investment recommendation on the company’s stocks. This project starts with a two pages analyst’s report, which summarizes the detailed analysis conducted in the main body of the work. It also provides a Buy or Sell recommendation based on this overview and highlights the risks em-bedded in the firm’s stocks. The main body of the report initiates by presenting an outlook on the nature of Debenhams’ business and later develops into a detailed analysis by evaluating the company’s strategy and financial performance. Finally, the company’s future earnings are forecasted for estimating the intrinsic value of Debenhams’ equity to determine whether the stock is fairly valued. This work is then con-cluded by summing up all the information obtained from the analysis to provide investors with a clear picture of Debenhams’ performance and assisting them in making informed investment decisions.

Executive Summary

Analyst’s Report

1. BASIC FACTuAl INFoRMATIoN

1.1 Nature of the Business

1.2 History and Development

1.3 Segmental Breakdown

1.4 Basic Statistics

2. CoRPoRATe STRATegy

2.1 Introduction

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

3.6 Analysis of the Retail Specific Ratios

3.7 Credit Worthness and Distress Prediction

3.8 economic Value Added

4. FoReCASTINg AND VAluATIoN

4.1 Introduction

4.2 Forecasting earnings

4.3 equity Valuation

Concluding Remarks

Bibliography

Appendices

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

Contents

DeBeNHAMS plc. lSe: DeB

22nd August 2013

Current Price: 108.50p Mean Target Price: 144.48p Recommendation: BUY

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 for-ward P/E multiples over the past five years

• Considerable decline in the company’s level of gearing and financing costs

• High expected growth in dividend yield, as a result of the recovery of the company’s re-tained earnings

• Relative and intrinsic valuation of the compa-ny, along with positive economic and industry outlooks suggest that the company’s stock price is undervalued; hence, a buy recommen-dation has been given.

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 com-pany in a vulnerable position should they re-quire writing down

Key Market Dataestimated Beta: 52 Week Range: Market Capitalization:Average Daily Volume:Trailing P/e Ratio:Forward P/e Ratio:P/S Ratio:Dividend yield:Market Short-Selling Activity:

1.4794.75 - 108.50 p

£ 1.38 bn4.6 m 11.0311.35

0.624.11 %

Low

Growth of £100

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, ac-cessories and home products. Debenhams operates as department stores in the uK, Denmark and the Repub-lic 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 sale’s growth in e-commerce. Moreover, Debenhams is ex-panding its brand internationally by opening franchise stores in the emerging markets. It is further attempting to increase awareness of the Debenhams brand by im-proving its products and own-bought participation, and increasing expenditure on marketing and advertising.

2010 2011 2012 2013(E) 2014(E) 2015(E)2,199.90

0.00215.96202.10

7.5-

2,209.80-0.30

184.72117.20

9.121.33%

2,229.801.60

195.43125.30

9.87.69%

---

122.419.56

-2.45%

---

125.219.77

2.20%

---

129.7910.133.68%

Revenue (£m)Like for Like Sales (%)

NOPAT (£m)Adjusted Net Income (£m)

Basic EPS (in pence)EPS Growth

% Return

201020112012YTD

-10.11-18.9489.433.98

Debenhams Industry FTSE 350 -4.52

-12.8330.2430.10

8.98-8.224.402.51

£180160140120100

80604020

0

2010 2011 2012

DebenhamsFTSe 350FTSe 350 gen Retail

2013

Debenhams plc. Analyst’s Report 2013i

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 uK’s 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.

Share Price Performance

Debenhams’ share price movement in the years 2010 to 2012 remained relatively stable and fol-lowed a similar trend to that of the company’s in-dustry 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 company’s price multiples. In 2013, both Debenhams and the uK retail industry have out-performed the FTSe 350 Index. The anticipated in-dustry growth based on positive economic outlooks along with the desirable uK climate in the summer of 2013, suggests that the upward trend of Deben-hams’ 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 mens-wear and womenswear and it is the 11th largest online retailer. Debenhams’ strong and long-lasting relationship with its suppliers has enabled it to en-joy 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 operat-ing profit margin of the company has been follow-ing a downward trend in the recent years. Research has further shown that the internal architecture of the company is weak, despite the company’s many efforts in improving the employees’ satisfaction. Finally, there have been concerns raised by Deben-hams’ internet customers regarding the company’s poor customer service.

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 compa-ny’s 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’ competi-tion with other retailers. Finally, if the Chinese gov-ernment’s proposed policy for increasing minimum wages is enacted, Debenhams’ costs of sales would increase considerably.

Forecasting

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 signifi-cant fall in comparison with the growth in previous years. This figure was obtained by averaging the outcomes of many different forecasting methodolo-gies. 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 company’s future performance.

Valuation

The relative valuation of Debenhams has indicated that the trailing and forward P/e multiples are sig-nificantly 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 div-idends 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 Reu-ters’ 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. Analyst’s Report 2013 ii

Debenhams plc. Analyst’s Report 20131

Debenhams plc. Analyst’s Report 2013 2

Debenhams plc is a multination-

al retail chain of British origin,

which trades under the symbol

“DeB” in the london Stock ex-

change and is a constituent of the

FTSe 250 Index.

The Debenhams brand is inter-

nationally recognized and is trad-

ed 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

countries. There are currently

over 29,000 individuals in full-

time and part-time employment

at Debenhams.

Debenhams offers a wide vari-

ety 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 & beau-

ty and home & furniture, and

has respectable market shares

in Menswear, womenswear and

childrenswear.

1.1 Nature of the Business

BASI

C FA

CTUA

L IN

FORM

ATIO

N


1778 – 1818: The Establish-ment of Clark & Debenham

In 1778, William Clark estab-

lished a whole sale clothes store

at 44 Wigmore Street in the West

end region of london, in which

he sold “expensive fabrics, bon-

nets, gloves and parasols”. The

shop was later named “Clark &

Debenham” following the invest-

ment of William Debenham in

the business in the year 1813. In

1818, a replica of the store on the

Wigmore Street was opened in

Cheltenham. (Debenhams, 2013)

1851: Debenham & Freebody

In 1851, Clement Freebody in-

vested in the company and as a

result the name of the business

was changed to Debenham &

Freebody. The business was then

further expanded to a wholesale

business in which items such a

cloth were sold to other retailers.

In the 19th century the business

was involved in the acquisition

of many businesses of retail,

wholesale and manufacturing

and it opened offices in Australia,

Canada, China, and South Africa.

(Debenhams, 2013)

1905 – 1928: From Debenhams Ltd to Debenhams PLC

The acquisitions that took place

in the late 19th century and

continued into the 20th century

resulted in the incorporation

of Debenhams ltd in 1905. In

1919, Debenhams ltd merged

with Marshall & Snellgrove and

in 1920 it acquired Harvey Nich-

ols. By the year 1928 the business

went public. (Debenhams, 2013)

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

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

1.2 History and Development


1950 – 1977: The Expansion of UK’s Largest Department Store

The fast growth of Debenhams

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-

til 1966, when for the first time

central buying was introduced

to the market. In 1977, all the

stores acquired by Debenhams

were rebranded from their orig-

inal names with the exception of

Brown’ of Chester. (Debenhams,

2013)

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 (current-

ly known as Arcadia PlC). During

this time the business strategy

of Debenhams was altered and

“more exclusive merchandise”

was introduced by Debenhams.

Furthermore, there was a signif-

icant rise in the number of the

Debenhams stores. Finally, in

1997, Debenhams’ first franchise

opened in the Middle eastern

country of Bahrain. (Debenhams,

2013)

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

1998 – Present: Debenhams in the Past Decade

upon demerging from the Burton

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 re-

turned in May 2006.

In 2007, Debenhams purchased

nine stores in the republic of Ire-

land, which was followed by the

further acquisition of Magasin du

Nord , a leading department store

chain in Denmark. in the Novem-

ber of 2009. (Debenhams, 2013)


Lines of Business

Debenhams has identified retail

as its only reportable segment.

However, the company offers a

wide range of products within this

segment, which have been sum-

marized in the graphs below.

The products sold by Debenhams

constitutes their own brands, (cat-

egorized as core and designer that

account for about half their sales),

international brands and their

concession brands, with some-

what equal shares of total sales.

The largest percentage of the

company’s annual sales in their

own-bought brands includes

Health and Beauty and womens-

wear. on the other hand, Food Ser-

vices, Sports & leisure and Home

& Furniture only take up about

4% of the total own bought sales.

Geographical Segments

Debenhams’ segmental reports

have only been available from the

August of 2009, when the compa-

ny adopted the IFRS 81. This was

following the acquisition of the

Danish chain Magasin Du Nord,

which was added to Debenhams

portfolio in 2009. Hence, the seg-

mental analysis can only be con-

ducted for the past three years.

Figure 7 indicates that the majori-

ty of the sales has been generated

by the uK segment. The underly-

Figure 5. Own Bought Sales by Category (2012)Figure 4. Sales by Brands (2012)

WomendwearMenswearChildrenswearlingerieAccessoriesHealth & BeautyHome & FurnitureSport & leisureFood Services

own bought core brandsown bought designer brandsown bought international brandsConcessions / Consignments

1.3 Segmental Breakdown

23%

12%

3%1% 0%

18%

14% 6%

10%

14%

1IFRS 8 requires the disclosure of operat-ing segments.


ing reason is that Debenhams has

only recently initiated its expan-

sion within the international mar-

kets, therefore, the company’s

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%

of Debenhams Non-current as-

sets are held by the uK segment.

Table 2. Segmental Revenue

Figure 7. Segmental Revenue

Denm

ark

Repu

blic

of

Irel

and

uK

Rest

of t

he W

orld

£m

2000

1800

1600

1400

1200

1000

800

600

400

200

0

Country № of Stores

15411668239

uKRepublic of IrelandDenmarkRest of the WorldToTAl

Revenue, £m

Revenue, £m

Revenue, £m

Change, %

Change, %

Change, %

2010 2011 2012

1,799.80

150.40

103.60

66.10

2,119.90

+6.47

-7.10

N/A

+4.42

+10.67

1,851.80

144.10

136.90

77.00

2,209.80

+2.89

-4.19

+32.14

+16.49

+4.24

1,860.30

136.50

142.70

90.30

2,229.80

+0.46

-5.27

+4.24

+17.27

+0.91

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

Table 1. Segmental Non-Current Assets

uKRepublic of Ireland

DenmarkRest of the World

ToTAl

2010(in £m) 2011 20121,469.60 1,436.00 1,476.10

40.80 39.20 32.10

29.10 35.20 33.30

N/A 0.60 4.30

1,539.50 1,511.00 1,545.80

84%

6%

6%4%

Figure 6. Debenhams Stores Concentration


Size

The market Capitalisation is a

good indication of a company’s

size. It is calculated by multiply-

ing the number of shares out-

standing with the market value of

the company’s stock. Debenhams’

current market capitalisation

of £1.3bn places it at the lower

end of the FTSe 250 index. As it

can be seen in graph 9, the mar-

ket capitalisation of Debenhams

has increased significantly in

the recent years from only about

£400m in 2008 to £1.2bn in 2012.

The company’s total assets have

increased considerably in the

recent years while its total lia-

bilities have decreased by about

20%. This has led to a major

increase in the company’s net

assets by over 500%.

Financial Performance

The analysis of Debenhams’ sales

in the past five years shows that

revenue increased each year.

However, from 2011 this growth

slowed down and in 2012 the

company’s sales grew by only

0.9%. Furthermore, The com-

pany’s operating profit has not

changed in these years, while

the net profit of the company

increased significantly. This is

an indication that the company’s

financing costs have decreased

by a large margin in the past five

years.

As shown in Figure 13, the ePS

trend has been somewhat vol-

atile. It had a peak of 10 pence,

which was followed by a rather

massive decline, however it was

later increased over a two year

period.

(in £m) 30 Aug 2008 29 Aug 2009 28 Aug 2010 03 Sept 2011 1 Sept 2012 1,984.301,859.00125.30383.65

2,135.801,710.50425.30690.12

2,087.301,583.90503.40690.66

2,018.201,358.60659.60648.52

2,091.201,430.20661.00

1,199.04

Total AssetsTotal liabilities

Net AssetsMarket

Capitalisation

Table 3. Assets and Liabilities

Figure 9. Market Capitalisation

2008

2009

2010

2011

2012

£m

1,400

1,200

1,000

800

600

400

200

0

1.4 Basic Statistics


2008

2009

2010

2011

2012

pence12

10

8

6

4

2

0

Figure 10. Trend of the Balance Sheet Indicators

earnings per Share

(in £m) 30 Aug 2008 29 Aug 2009 28 Aug 2010 03 Sept 2011 1 Sept 2012 1,839.20176.1077.109.00

1,915.60182.2095.1010.00

2,119.90189.7097.007.50

2,209.80183.70117.20

9.10

2,229.80175.00125.30

9.80

RevenueOperating Profit

Net Profitearnings per Share

(In Pence)

Table 4. Key Financial Indicators

Figure 13. Debenhams EPS TrendFigure 12. EBIT and Net Profit Trends

Figure 11. Revenue Trend

2008

2009

2010

2011

2012

£m

2,500

2,000

1,500

1,000

500

0

2008

2009

2010

2011

2012

£m200

180

160

140

120

100

80

60

40

20

0

2008

2009

2010

2011

2012

£m

2,500

2,000

1,500

1,000

500

0

Operating ProfitNet Profit

Total AssetsTotal liabilities Net Assets


Corporate strategy is a manage-

ment practice utilized by com-

panies and enterprises around

the globe with the aim of im-

proving the firm’s competitive

strategy and adding value to the

business (Porter, 1980). Porter

(1980) identified activities such

as “industry analysis, competitor

analysis and strategic position-

ing” as the major disciplines of

competitive strategy. He further

formulated the competitive strat-

egy of a company by identifying

the key factors, which “determine

the limits of what a company can

successfully accomplish.”

When evaluating Debenhams’

strategy, it is important to con-

sider both micro-environmental

and macro-environmental fac-

tors that affect its performance.

Micro-environmental factors are

those, such as the relationship of

the company with its customers,

suppliers, shareholders, com-

petitors, media, and employees.

Macro-environmental factors on

the other hand, attempt to ana-

lyse the effects that political, eco-

nomic, regulatory, and industrial

changes have on the performance

of the company (McDonald &

Christopher, 2003).

The method by which Deben-

hams’ strategy is analysed, is the

Top-down approach. The reason

for this choice lies behind the

cyclical nature of the retail indus-

try. The retail and wholesaling

sectors have particularly been

extremely sensitive to economic

cycles in the past. They were hit

hard during financial recessions

and recovered as the economy

picked up (oFT, 1997). The top-

down analysis enables looking at

the big picture before analysing

the specific characteristics of the

individual company.

Figure 14. Top-Down Analysis (Source: www.online-stock-trading-guide.com)

2.1 Introduction

CORP

ORA

TE S

TRAT

EGY


A retailer’s ability in generating

long-run profits is heavily influ-

enced by the macro-environmen-

tal conditions. Therefore, analys-

ing Debenhams’ strategy requires

the examination of the external

environment surrounding the

company and the forces that have

direct or indirect impacts on its

performance. For conducting

this analysis, the PeSTle meth-

odology has been used, which

examines the political, economic,

social, technological, legal and

environmental factors that affect

the company’s performance.

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 at-

taining a free market economy. Some

examples are removing the restric-

tions on the stores opening hours in

the year 1994 and the amendment

of the resale price maintenance in

the book trade in 1995 (Burt et al,

2010).

In 2011, the government’s Plan for

growth policy aiming to stimulate

the economy by reducing bureau-

cracy and promoting the growth

of small businesses was put into

effect (BBC, 2011). According to the

uK government’s website (2013),

many regulations on uK businesses

are “ineffective and unnecessary”

and “complying with them costs

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

for new business regulations. The

examination of the new regulations,

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 im-

pact on the performance of the uK

retailers.

2.2 Macro-Environment Analysis


Impact on the Economy

In March 2013, upon the announce-

ment of the 0.6% UK growth fore-

cast, the revised budget plan was

delivered to the uK parliament

(BBC, 2013). According to the

2013 budget, capital spending will

be increased by £3bn a year from

2015 to 2016 by cutting current

spending (uK government, 2013).

Furthermore, in order to promote

growth and help uK businesses

in creating jobs, the main rate of

corporation tax is reduced to 20%.

This decrease in corporate taxes

would result in the higher profit-

ability of the uK retailers such as

Debenhams.

A possible risk for Debenhams is

the increase in the supplier costs.

According to BBC (2013), China

has approved a plan that increas-

es the Chinese minimum wage to

40% of average urban salaries by

2015. If this plan is put into effect,

the higher Chinese labour costs

will in turn increase Debenhams’

costs of goods.

Political Stability

With regards to political stability

in 2013, the world map in the

next page reveals that Britain,

Republic of Ireland and Denmark

have very low political risks,

while China on the other hand is

shown to have a relatively high

risk. The political risks in China

range from “nationalisation of

industries, through asset confis-

cation and onto contract repudi-

ation with respect to government

entities” (China Risk Manage-

ment, n.d.). one of the major

political risks, which affect the

suppliers and may have adverse

effect on Debenhams is the battle

between the local and central

governments, meaning that often

the suppliers do not know which

rules to follow.

In 2013, the credit rating agency

of Moody’s (2013) downgraded

uK’s domestic and foreign cur-

rency government bond ratings

from Aaa to Aa1. This resulted

in the increase of the country’s

political risk premium. Moody’s

(2013) justified this downgrade

by highlighting the risks that may

arise from the execution of uK’s

fiscal plans. A higher risk premi-

um means that when calculating

the cost of equity of the company,

a Country Risk Premium needs to

be added to the equity risk pre-

mium as follows:

Ke=rf+β(ERP+CRP)


FINLA

ND

AUST

RIA

ITALY

SPAIN

SWED

ENNO

RWAY

GERM

ANY

FRAN

CE

ANDO

RRA

PORT

UGAL

HUNG

ARY

ROMA

NIA

BULG

ARIA

DENM

ARK

POLA

NDBE

LARU

S UKRA

INECZ

ECH

SLOV

AKIA GR

EECE

CYPR

US

NETH

.BE

LGIUM LU

X.

IRELA

ND

SERB

IA

MONT

ENEG

RO ALBA

NIA

MOLD

OVA

LITHU

ANIA

LATV

IAES

TONIA

BOSN

IA-HE

RZCR

OATIA

SLOV

ENIA

SWITZ

.

MACE

DONIA

GREE

NLAN

D

ICELA

ND

THE B

AHAM

AS

CUBA

PANA

MA

EL SA

LVAD

ORGU

ATEM

ALA

BELIZ

E

HOND

URAS

COST

A RICA

HAITI

ARGE

NTINA

BOLIV

IA

PERU

BRAZ

IL

FREN

CH G

UIANA

SURIN

AME

GUYA

NA

CHILE

ECUA

DOR

PARA

GUAY

URUG

UAY

KENY

A

ETHIO

PIA

EGYP

T

NIGER

MAUR

ITANIA

MALI

NAMI

BIA

SOUT

H AFR

ICA

TANZ

ANIA

ANGO

LA

ALGE

RIA

MADA

GASC

AR

MOZA

MBIQ

UE

BOTS

WANAZA

MBIA

GABO

N

TUNIS

IA

MORO

CCO

UGAN

DA

SWAZ

ILAND

LESO

THO

MALA

WI

BURU

NDI

RWAN

DA

TOGOBE

NIN

GHAN

AIVO

RYCO

AST

LIBER

IA

SIERR

A LEO

NEGUINE

ABU

RKINA

FASO

GAMB

IA

CAME

ROON

SAO

TOME

& PR

INCIPE

CONG

O

EQUA

TORIA

L GUIN

EA

DJIBO

UTI

SENE

GAL

GUINE

A BISS

AU

CANA

RY IS

LAND

SJO

RDAN

ISRAE

L

LEBA

NON

ARME

NIAAZ

ERBA

IJAN

GEOR

GIA

KYRG

YZST

AN

TAJIK

ISTAN

KUWA

IT

QATA

RBA

HRAIN

U. A.

E. OMAN

SAUD

I ARA

BIA

KAZA

KHST

AN

TURK

MENIS

TAN

UZBE

KISTA

N

THAIL

AND CA

MBOD

IA

NEPA

LBH

UTAN

VIETN

AM

SRI L

ANKA

LAOS MA

LAYS

IAMA

LAYS

IA

PAPU

ANE

W GU

INEA

EAST

TIMO

R

BRUN

EI

SINGA

PORE

MONG

OLIA

SOUT

H KOR

EA

AUST

RALIA

NEW

ZEAL

AND

U.K.

NEW

CALE

DONIA

FIJI

VENE

ZUEL

A

P.O.T

U. S.

A.

JAPA

N

TAIW

ANME

XICO

PHILI

PPINE

S

TURK

EY

INDO

NESI

A

CANA

DA

DOM.

REP.

ANTIG

UA AN

D BAR

BUDA

ST LU

CIAST

. VINC

ENT A

ND TH

E GRE

NADIN

ES

DOMI

NICA

BARB

ADOS

JAMA

ICA

NICAR

AGUA

GREN

ADA

TRINI

DAD A

ND TO

BAGO

VANU

ATU

SOLO

MON I

SLAN

DS

NORT

H KOR

EA

CHINA

IRAN

CHAD

BANG

LADE

SH

ERITR

EA

ZIMBA

BWE

INDIA

FALK

LAND

ISLAN

DS

RUSS

IA

AFGH

ANIST

AN

MYAN

MAR

PAKIS

TAN

LIBYA

C.A.R

SUDA

N

DEM.

REP.

OF CO

NGO

SOMA

LIA

YEME

N

IRAQ

NIGER

IA

SYRIA

SOUT

H SUD

AN

COLO

MBIA

Arc

tic O

cean

Ind

ian

Ocean

Atla

ntic

O

cean

Polit

ical

Ris

k 20

13

© M

aple

crof

t 201

3 | T

he T

ower

s, St

Ste

phen

’s R

oad,

Bat

h B

A1

5JZ,

Uni

ted

Kin

gdom

| t:

+44

(0) 1

225

420

000

| ww

w.m

aple

crof

t.com

| in

fo@

map

lecr

oft.c

om

The

Politi

cal R

isk (D

ynam

ic) In

dex

asse

sses

risk

s th

at h

ave

the

pote

ntia

l to

unde

rgo

chan

ge, a

nd in

par

ticul

ar

to d

eter

iora

te, r

apid

ly du

e to

dire

ct g

over

nmen

t act

ion,

bus

ines

s ac

tivitie

s or

due

to a

ctio

n by

sub

-sta

te o

r oth

er

politi

cally

-mot

ivate

d gr

oups

. It i

s co

mpr

ised

of 2

9 po

litica

l risk

indi

ces

unde

r the

four

them

es o

f gov

erna

nce

fram

ewor

k, p

olitic

al v

iole

nce,

bus

ines

s an

d m

acro

econ

omic

risk

and

socie

tal f

orce

d re

gim

e ch

ange

risk

. Th

e Po

litica

l Risk

(Dyn

amic)

Inde

x is

part

of M

aple

crof

t’s P

olitic

al R

isk A

tlas

(PRA

) 201

3.

In a

dditio

n to

ass

essin

g sh

ort t

erm

, dyn

amic

risks

, the

PRA

201

3 als

o inc

orpo

rate

s the

Poli

tical

Risk

(Stru

ctura

l) In

dex,

which

ass

esse

s lon

g te

rm p

olitic

al ris

ks, s

uch

as in

frastr

uctu

re re

adine

ss a

nd so

cieta

l res

ilienc

e, w

hich

cont

ribut

e to

a co

untry

’s lon

g te

rm g

rowt

h en

viron

men

t. By

ana

lysing

bot

h dy

nam

ic an

d str

uctu

ral r

isks,

the

PRA

2013

thus

ena

bles b

usine

sses

and

inve

stors

to m

ake

an a

sses

smen

t of t

heir

expo

sure

to a

com

preh

ensiv

e ra

nge

of

politi

cal r

isks a

nd ta

ke st

eps t

o m

itigat

e th

em.

Ris

k an

d op

portu

nity

hot

spot

s in

key

gr

owth

mar

kets

© M

aple

crof

t 201

3

For m

ore

infor

mat

ion se

e ww

w.m

aplec

roft.

com

or c

onta

ct in

fo@

map

lecro

ft.co

m

Polan

d Ma

croec

onom

ic En

viron

ment

Index

: 6.98

Mexic

oHu

man

Sec

urity

Ri

sk In

dex:

2.09

Tanz

ania

Politi

cal V

iolen

ce

Inde

x: 7.

12

Indo

nesia

Reso

urce

Nati

onali

sm

Index

: 3.86

Peru

Regim

e St

abilit

y In

dex:

7.58

Chile

Corru

ption

Risk

In

dex:

6.72

Nige

riaRe

mitta

nces

Risk

In

dex:

5.02

Chin

aRe

sour

ce N

ation

alism

In

dex:

5.35

Russ

iaRe

gime

Stab

ility

Inde

x: 6.

37

Indi

aCo

nflict

and

Poli

tical

Vi

olenc

e In

dex:

2.12

Viet

Nam

Socie

tal F

orce

Reg

ime

Ch

ange

Inde

x: 3.

83

Braz

ilBu

sines

s and

Mac

roec

onom

ics

Index

: 5.48

Arge

ntin

aRe

sour

ce N

ation

alism

In

dex:

4.06

Po

litic

al R

isk

(Dyn

amic

) Ind

ex 2

009-

2013

: BR

ICs

10 8 6 4 2 020

0920

1020

1120

1220

13

Braz

il

China

India

Russ

ia

Political Risk (Dynamic)

Polit

ical

Ris

k (D

ynam

ic) I

ndex

:To

p 20

Gro

wth

Mar

kets

Coun

tryRa

nkRa

ting

1Ch

ina61

High

2In

dia35

High

3In

done

sia60

High

4Vi

et N

am70

Med

ium5

Bang

lades

h33

High

6Br

azil

109

Med

ium7

Philip

pines

29Hi

gh8

Nige

ria16

High

9So

uth

Kore

a16

1Lo

w10

Mala

ysia

123

Med

ium11

Russ

ia17

High

12Ta

nzan

ia83

Med

ium13

Sing

apor

e18

0Lo

w14

Hong

Kon

g (C

hina)

177

Low

15Pe

ru97

Med

ium16

Thail

and

63Hi

gh17

Egyp

t27

High

18Co

lombia

49Hi

gh19

Turk

ey71

Med

ium20

Uzbe

kista

n43

High

Polit

ical

Ris

k (D

ynam

ic) I

ndex

:To

p 20

hig

hest

risk

Rank

Coun

tryRa

ting

1So

mali

aEx

trem

e2

DR C

ongo

Extre

me

3Su

dan

Extre

me

4Af

ghan

istan

Extre

me

5M

yanm

arEx

trem

e6

Libya

Extre

me

7Ira

qEx

trem

e8

C.A.

REx

trem

e9

Syria

Extre

me

10Ye

men

Extre

me

11So

uth

Suda

nEx

trem

e12

Pakis

tan

Extre

me

13No

rth K

orea

High

14Cô

te d

’Ivoir

eHi

gh15

Zim

babw

eHi

gh16

Nige

riaHi

gh17

Russ

iaHi

gh18

Chad

High

19Bu

rund

iHi

gh20

Iran

High

Myan

mar

Regim

e St

abilit

y In

dex:

4.60

UK

RA

INE

IRA

Q

RU

SS

IA

EG

YP

T

UK

RA

INE

SA

UD

I A

RA

BIA

SY

RIA

RO

MA

NIA

BU

LGA

RIA

JOR

DA

N

GE

OR

GIA

MO

LDO

VA

AZ

ER

BA

IJA

NA

RM

EN

IA

ISR

AE

L

KA

ZA

KH

STA

N

CY

PR

US

LEB

AN

ON

MA

CE

DO

NIA

Anka

ra

Izmir

Ceyh

an

Istan

bul

Diya

rbak

ir

SA

NLI

UR

FA

DIY

AR

BA

KIR

SIR

NA

K

HA

KK

AR

I

GA

ZIA

NT

EP

Conf

lict a

nd p

oliti

cal v

iolen

ce

020

040

010

0km

© M

aple

crof

t, 20

12

map

lecro

ft™

! \Na

tiona

l cap

ital

\Ot

her m

ajor c

ities a

nd to

wns

Adm

inistr

ative

bou

ndar

y

Data

sour

ce: M

aplec

roft,

201

2

Extre

me

Risk

Low

Risk

High

Risk

Mediu

m R

isk

High

er lo

calis

ed in

tens

ity

Loca

lised

Terro

rism

Inte

nsity

Inde

x 201

3Co

nflic

t and

Pol

itica

lVi

olen

ce In

dex

2013

!Lo

w

!Me

dium

!Hi

gh

!Ex

trem

e

Con

flict

and

Pol

itica

l Vio

lenc

e In

tens

ity

Inde

x: T

urke

y

Turk

eyTe

rroris

m R

isk

Inde

x: 1.

50

Egyp

tPo

litica

l Viol

ence

In

dex:

3.10

Polit

ical

Ris

k Le

gend

No d

ata

Decr

easin

g Ri

sk

Incr

easin

g Ri

skNo

Impr

ovem

ent

Extre

me

Risk

>0.0

0 –

1.25

>1

.25

– 2.

50M

edium

Risk

>5.0

0 –

6.25

>6

.25

– 7.

50

Low

Risk

>7.5

0 –

8.75

>8

.75

– 10

.00

High

Risk

>2.5

0 –

3.75

>3

.75

– 5.

00

Conf

lict a

nd P

oliti

cal V

iolen

ce In

tens

ity In

dex

2013

Low

Med

iumHi

gh

Extre

me

Loca

lised

Terro

rism

Inte

nsity

Inde

x 20

13

!!

!Lo

wM

edium

High

Ex

trem

e

!Na

tiona

l cap

ital!

Othe

r majo

r citie

s and

town

s

Data

sour

ce: M

aplec

roft,

201

2; W

ITS-

NCTC

, 201

2

BR

AZ

IL

PE

RU

VE

NE

ZU

ELA

EC

UA

DO

R

NIC

AR

AG

UA

PAN

AM

A

CO

STA

RIC

A

HO

ND

UR

AS

CU

RA

ÇA

OA

RU

BA

NE

TH

ER

LAN

DS

ME

TA

CA

QU

ET

Á

AN

TIO

QU

IA

GU

AV

IAR

E

CA

UC

A

AR

AU

CA

CH

OC

Ó

NA

RIÑ

O

CE

SA

R

HU

ILA

TOLI

MA

CÓ

RD

OB

A

PU

TU

MA

YO

LA G

UA

JIR

A

VA

LLE

DE

L C

AU

CA

NO

RT

E D

ES

AN

TAN

DE

R

RIS

AR

ALD

ABo

gota

Cali

Mede

llin

Carta

gena

Barra

nqui

lla

Conf

lict a

nd p

oliti

cal v

iolen

cem

aplec

roft™

Data

sour

ce: M

aplec

roft,

201

2

020

040

010

0km

© M

aple

crof

t, 20

12

! \Na

tiona

l cap

ital

\Ot

her m

ajor c

ities a

nd to

wns

Adm

inistr

ative

bou

ndar

y

Loca

lised

Terro

rism

Inte

nsity

Inde

x 201

3Co

nflic

t and

Pol

itica

lVi

olen

ce In

dex

2013

!Lo

w

!Me

dium

!Hi

gh

!Ex

trem

e

Extre

me

Risk

Low

Risk

High

Risk

Mediu

m R

isk

High

er lo

calis

ed in

tens

ity

Con

flict

and

Pol

itica

l Vio

lenc

e In

tens

ity

Inde

x: C

olom

bia

Colo

mbi

aCo

nflict

and

Poli

tical

Viole

nce

Inde

x: 0.

74

Prin

cipa

l Pol

itica

l Risk

In

sura

nce

Cov

erag

esCo

vera

ge

Type

Prot

ects

Again

st:

Expr

opria

tion

Host

Gove

rnme

nt ac

ts int

erfer

ing

with

funda

menta

l own

ersh

ip rig

hts

of the

inve

stor’s

inter

est in

a Fo

reign

En

terpr

ise, in

cludin

g con

fisca

tion,

natio

nalis

ation

, sele

ctive

disc

rimina

tion

and “

creep

ing ex

prop

riatio

n”.

Politi

cal

Viole

nce

Phys

ical d

amag

e los

s to a

ssets

loca

ted

over

seas

caus

ed by

politi

cal v

iolen

ce

(war,

civil

war,

revo

lution

, insu

rrecti

on,

strike

s, rio

ts, sa

botag

e and

terro

rism)

.

Forc

ed

Aban

donm

ent

Aban

donm

ent o

f a F

oreig

n Ente

rpris

e as

a res

ult of

advic

e by t

he di

rect

inves

tor’s

home

gove

rnme

nt to

evac

uate

key

expa

t per

sonn

el fro

m the

Hos

t Cou

ntry

beca

use o

f Poli

tical

Viole

nce.

Busin

ess

Inte

rrupt

ion

Loss

of bu

sines

s inc

ome b

y the

Insu

red

resu

lting a

s a co

nseq

uenc

e fro

m

busin

ess o

pera

tions

in th

e Hos

t Cou

ntry

havin

g bee

n inte

rrupte

d by P

olitic

al Vi

olenc

e or E

xpro

priat

ion.

Curre

ncy

Restr

iction

s

Delay

or in

abilit

y of a

For

eign E

nterp

rise

to ex

chan

ge lo

cal c

urre

ncy i

nto ha

rd

curre

ncy (

incon

vertib

ility)

or to

repa

triate

hard

curre

ncy f

unds

outsi

de th

e Hos

t Co

untry

(Non

-tran

sfer).

(Sou

rce:

Mar

sh, 2

013)


Economic Environment

Global, EU and The British Economic Growth

The uK economy witnessed a

0.3% growth in GDP in the first

quarter of 2013 and it was fol-

lowed by a 0.6% growth in the

second quarter. The graph below

shows uK’s historic gDP trends

and the future prospects for the

economy as forecasted by PwC

(2013). The most likely estimat-

ed scenario is rather positive,

with an expected growth of 1%

in 2013, and a growth of 2% in

2014.

A survey conducted by PMI

indicated that in the past few

months all the major uK sectors

had shown signs of recovery. The

retail sector’s growth in sales in

May 2013 has further improved

Debenhams’ prospects (PwC,

2013).

In the second quarter of 2013,

the Eurozone grew by 0.3% after

18 months of economic contrac-

tion, which led into its emergence

from recession. This growth was

ahead of the forecasts mainly due

to the 0.7% GDP growth of the

german economy (BBC, 2013).

These figures all indicate that

the prospects for the Irish seg-

ment of Debenhams, which had

experienced negative growth in

sales in the past few years may be

positive, as there are hopes of im-

provements of the sales growth.

Figure 15. GDP Growth Scenarios


The forecasts of the uK consumer

spending are similar to that of

gDP, but somewhat weaker due

to the negative growth in the real

earnings. Positive real growths

are forecasted to occur from 2015

onwards.

According to The economist

(2013), the global GDP in the first

quarter of 2013 grew by only 2.1%,

when this figure at the same time

in 2012 was at a reasonable 3.1%

rate.

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

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


tative easing (Qe) performed by

the government. However, it is

believed that the investor’s atti-

tude towards risk will return to

its normal level and it is estimat-

ed that by 2025 the 10 year gilt

rates will be around 4 – 5.5%.

Housing Prices

The house prices are expected

to recover based on figure 18.

House prices have been fore-

casted to reach their peak in real

terms (i.e. adjusted for inflation)

by 2021. This would, however,

affect Debenhams negatively, as

they will have to purchase new

stores at higher prices. Hence,

any plans for domestic expansion

has to take effect immediately.

Inflation

The consumer price index has

been rather unstable in the

past few months and PwC’s

(2013) economic outlook sug-

gested that the inflation could

go as high as 3% over the sum-

mer period, which is above the

target rate of 2.7%. The figures

released in August 2013 indi-

cate the inflation rate had been

at a moderate 2.8%, which is

close to that of the target (BBC,

2013). Based on the estima-

tions, the inflation rate in 2014

is expected to be above the tar-

get of 2.4% (PwC, 2013).

High levels of inflation mean that

there will be further declines

in the real earnings growth and

no positive growth is expected

until the years 2015 – 2017. on

the positive side, the uK em-

ployment growth has had an

upward trend and the improved

employment rates could increase

the household income. Further-

more, following the government

spending cuts, the non-employ-

ment incomes are also expected

to continue growing until 2016

(PwC, 2013). All this may result

in increased growth in the retail

sector, which in turn would bene-

fit Debenhams.

Interest Rates

government bond rates in the re-

cent years have been rather low

mainly due to the risk aversion

of the investors and the Quanti-

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


Social Trends and . The Environment

Age distribution

According to figure 19 Deben-

hams’ main customers are the

middle aged segment of the pop-

ulation. The projections for 2033

show that the highest proportion

of the uK population comprise of

middle aged individuals, which

benefits Debenhams in the long-

run.

Consumer confidence

According to Reuters (2013), the

British consumer confidence has

reached its highest in more than

three years. With the gDP dou-

bling to 0.6% in the second quar-

ter of 2013 and increased growth

in the retail sector, it is evident

that the uK economy is showing

signs of recovery.

Climate

The performance of retailers

is often influenced by weather

conditions. The British climate

was rather volatile in 2013 with

a cold start to spring in April,

which hit the retailers hard and

slowed down the growth of large

department stores such as De-

benhams. However, according to

British Retail Consortium (BRC),

from May 2013 the retailers en-

joyed increased sales, with July

experiencing a 2.2% growth. The

growth in July, which was the

highest in seven years, was due

to that month’s heat wave (BBC,

2013). BRC further reported that

online sales grew only by 7.9%,

which is relatively lower than

other months. This shows the

positive impact of a good weather

on consumers, which encourages

them to leave houses and visit

high street shops.

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

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


Technological Advancements

The retail industry in the recent

years experienced rapid growth

in sales through multi-channel

and e-commerce. Department

stores such as Debenhams have

first-hand witnessed the rapid

growth in online sales, which at

times were at rates of around

200%, over only a one year peri-

od.

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-

structures to improve mobility

by Mobile point-of-sale and some

other devices, which improve in-

ventory management, customer

services, and the company’s se-

curity (Aruba, 2013).

According to a forecast, all these

new technologies stated above

are expected to contribute

£2.4bn to the total sales in retail

by the end of 2013 (The guardi-

an, 2013).

Figure 21. UK Consumer Confidence(Source: gFK, 2013)


The industry in which a company

competes is a major element in

understanding the company’s

environment. The industry can

be described as a group of com-

panies which produce goods that

are close substitutes of one an-

other. The structure of the indus-

try determines the competition

rules, as well as the strategies

available to the companies (Por-

ter, 1980).

Porter further discussed that

in an industry the state of the

competition is dependent on five

competitive forces. These five

forces put together determine the

potential profitability of the com-

pany in the industry. By utilizing

Porter’s five forces, the competi-

tive environment of Debenhams

is analysed.

Economies of Scale – High

In the past few decades there has

been a decrease in the number

of independent retailers. The in-

creased size of many uK depart-

ment stores and their vertical

organizational structures has

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-

sible to break the entry barriers,

the competitive advantages of

incumbents due their cost ad-

vantages make entry virtually

impossible.

2.3 Industry Analysis and Competitive Environment

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

Capital Requirements – Moderate/High

entering the retail industry may

require relatively high capital

investments. The entrant has to

incur costs for advertising, mar-

keting, set-ups, licensing, product

registration and contracts with

suppliers in an attempt to gain

market share.

An article by the office of fair trad-

ing noted that although it has yet

not been proven whether capital

requirements constitute barriers

to entry, they definitely slow it

down. Incumbent retailers ap-

pear to raise capital relatively eas-

ier than the entrants (oFT, 1997).

Threat of Entry - MODERATE / LOW


0 1 2 3 4 5

Economies of Scale

Capital Requirements

Cost Advantages Independent of

Scale Legal Barriers

Access to Retail Sites

Threat of New Entrants Figure 23. Threat of New Entrants

Cost advantages Independent of Scale - High

Factors such as long-term rela-

tional contracts with suppliers,

having first move advantages in

accessing favourable geograph-

ical locations and steep experi-

ence curves have given incum-

bents absolute cost advantages

and have resulted in deterrence

of entry (oFT, 1997).

Legal Barriers - Moderate/Low

government policies such as the

planning regulation of 1996, and cer-

tain 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,

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-

cracy and stimulate the economy

(BBC, 2011).

Access to Retail Sites – Moderate

For retail stores such as Deben-

hams, having access to “prime

geographical locations” is of vital

importance (oFT, 1997). Access

to retail sites is often considered

a barrier to entry, when there

have been governmental and

regulatory interventions, which

set restrictions and limitations

on the entrants (oFT, 1997). For

instance in 1996, the implemen-

tation of planning regulations by

the British government resulted

in the rapid decline of planning

grants to large retailers. This

policy required retailers, which

were planning on opening stores

that were over 2,500 square me-

ters in size, to pass a “sequential

test” and a “test of need” (Sadun,

2008).

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


Rivalry Amongst Existing Competitors HIGH

Concentration – Moderate/High

In 1980s, following the relaxation

of the restrictions on uK retailers,

many companies took advantage

of the growth cycle by increasing

their sizes and market concen-

trations. Department stores such

as Debenhams, Marks & Spencer,

John lewis and House of Fraser

have increased significantly in

size and have taken a considera-

ble share of the overall market.

Industry Growth – Slow

As discussed earlier, in July 2013

the high street sales increased

by 2.2%. This rapid growth has

been mainly due to the desira-

ble climate in this month. The

average growth in the retail

industry for the year 2013 has

been forecasted to be rather flat,

at a rate of 0.3% in real terms,

which is similar to the growth in

2012. However, the street retail

sales are expected to continue

declining, with total sales having

been estimated to fall by -1.9%

for the fourth subsequent year

(Retail Research, 2013). The slow

growth in the uK retail industry

means that companies must com-

pete fiercely in order to be able to

capture market share.

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

costs are not linked with the sales

performance of the company and

rents generally increase regard-

less of the overall performance

of the market (Burt, Sparks, &

Teller, 2010).

on the other hand, the major

variable cost of retailers is their

labour force. However, according

to a study, 60% of the UK retail

employees are part-time and

64% are female, 70% of which

also work part-time. This gives

flexibility to the retailers and

allows them to reduce their var-

iable expenses (Burt, Sparks, &

Teller, 2010). Therefore the ratio

of fixed to variable costs is rela-

tively high.


Switching costs – Moderate

Department stores such as De-

benhams and Marks & Spencer

have managed to reduce consum-

ers’ search costs by providing a

“one-stop shopping service” and

offering a wide range of relatively

similar products (oFT, 1997). Ac-

cording to the office of fair trad-

ing (1997) search costs and shop-

ping costs have both contributed

to the reluctance of consumers

in switching from their regular

retailers. Furthermore, as long as

the quality of consumers’ retail

services do not decrease signifi-

cantly, individuals would rather

stick to their usual retail stores

and avoid incurring search costs.

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

and hence, there are limited

regulatory barriers from exiting

the industry. However, there are

some social aspects to this. For in-

stance, exit from the industry by

giants such as Debenhams, which

have over 30,000 employees

would result in many job losses

and may have an adverse impact

on the overall well-being of the

economy. There is further the is-

sue of emotional barriers and the

management’s “unwillingness to

make economically justified exit

decision” (Porter, 1980). Figure 25. Rivalry Among Existing Competitors


Threat of Substitute Products - HIGH

Bargaining Power of Buyers - LOW

Substitute Products – High

There are many substitute prod-

ucts offered by retailers with

similar functions and purposes.

Fashion clothing, accessories

and home furniture are easily

replicable and can be produced

at relatively low costs and sold at

reasonable prices.

Substitute Services – High

The growth in the retail industry

in 2012 was around 0.5%, howev-

er, most of this growth was main-

ly due to the rapid increase in

the sales of online retail services,

which contributed to only 3% of

the total retail sales in 2007 and

increased to over 10% of the total

sales by 2012. The sales’ growth

of street retailers has been neg-

ative in the past four years. The

rapid growth in e-commerce and

online services is expected to cre-

ate many substitute services and

strip a large share of the market

from physical retailers.

Figure 26. Average Internet Retail Sales (£million) (Source: oNS, 2013)

According to the office of fair

trading (1997) the end-consumer

of retail stores can be described

as “Small, Immobile and Unin-

formed”. Customers have been

characterised as being small,

since their purchases constitute

only a fraction of both the cus-

tomers’ total expenditures and

retailers’ total sales. Consumers

have been further regarded as

being immobile, since they prefer

avoiding search and shopping

costs and are therefore not will-

ing to travel far distances in the

pursuit of finding appropriate

products. Finally, consumers are

uninformed, as they do not have

any knowledge about the avail-

ability of products, their prices

and their qualities. Due to all

these characteristics, it is clear

that the consumers have little to

no bargaining power (oFT, 1997).


Bargaining Power of Suppliers - LOW

uK retailers desire to sell high

quality products and they often

do this by carrying inspections

and conducting quality controls

or by managing the manufactur-

ing process in order to ensure that

the products meet the required

standard. When there is asym-

metry of information between

the suppliers and retailers, the

retail companies may intervene

by managing the supply process.

Furthermore, a retailer such as

Debenhams, which is concerned

about its reputation and wants to

maintain its perception on exclu-

sivity, may require its suppliers

to avoid supplying to any other

retailers (oFT, 1997).

Retailers as the sellers of fi-

nal goods are closest to the

end-consumer and have detailed

information about products.

Therefore, the market power has

been shifted towards retailers

and away from the suppliers, as

the supply chain management is

often carried out by the retailers

(oFT, 1997).

Figure 27. Analisys of Porter’s Five Forces

Figure 28. Five Forces of the Retail Industry

Threat of EntryMODERATE / LOW

Industry CompetitionHIGH

Industry ProfitabilityMODERATE

Buyer’s Bargaining PowerLOW

Supplier’s Bargaining PowerLOW

CoMPeTITIVe THReATS

BARgAININg PoWeR oF SuPPlIeRS/BuyeRS

Threat of SubstitutesHIGH


2.4 Analysis of Debenhams’ Business Strategy

Strategic Objectives

This section briefly outlines De-

benhams’ strategic objectives

and the actions which have been

undertaken by the firm’s man-

agement in the pursuit of these

goals. It is important to compre-

hend the direction, at which the

company is aiming at, as this will

enable understanding whether

the goals of the company are in

line with the maximisation of the

shareholders’ value.

The majority of this information

has been retrieved from the 2012

annual report and the company’s

website, which merely summa-

rize the company’s strategic

plans. Where necessary, the com-

pany’s objectives are evaluated

by referring to external sources

to identify, whether Debenhams’

plans have been helpful in im-

proving the firm’s overall perfor-

mance. external sources are also

the means of providing outside

perspective on the company’s

strategy.

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


Focusing on UK retail

The first objective of Debenhams

(2012) has been the modern-

isation of 30 of its 154 stores,

which had remained un-invested.

Debenhams claims that the sole

purpose of this modernisation

is meeting the demand of its

customers for a modern shop to

improve customer’s perceptions

on the Debenhams brand. They

further aim at improving the

choice offered in their stores so

that it meets the local demands.

Debenhams is further attempting

to increase the number of the uK

stores by opening and operating

70 new stores, which they believe

will increase their sales by £1

billion and result in economies of

scale. The new stores that were

opened in 2011 increased sales

by 5.8% and created 350 jobs

(Debenhams, 2011).

Delivering a compelling cus-tomer proposition

Debenhams (2012) is planning

to offer its customers a unique,

differentiated and exclusive col-

lection of brands. They have also

been attempting to improve per-

formance by raising the stand-

ards of visual merchandising and

product differentiation as well

as increasing the marketing and

advertising expenses in 2012,

which have supposedly increased

their sales.

Debenhams has shown its pride

on the company’s own-bought

sales participation, which in 2011

constituted 80.4% of their total

sales. However, in 2010, the City

traders were shocked by a “fore-

cast-busting” 18.6% increase in

the pre-tax profit to £123.6m,

when the like-for-likes were

only raised by 0.3% (Shields,

2010). Debenhams explained

this “modest” increase with the

company’s attempts in shifting

store space “to its higher margin

own-brand offer at the expense

of concessions” (Shields, 2010).

This justification may have been

reasonable, as in 2013, Deben-

hams’ like-for-like sales rose by

3.1% (Internet Retailing, 2013).

Increasing availability and choice through multi-channel

Debenhams’ focus in 2013 is on

increasing the choice of brands,

products and categories, which

are sold online and offering a

better range of delivery options.

This is a wise objective, as in the

first half of 2013, Debenhams’ in-

terim statements showed a 46%

growth in e-commerce sales to

£194.4m. Furthermore, 12.7% of

Debenhams sales› are generated

online (Internet Retailing, 2013).

Debenhams is hoping to increase

the e-commerce turnover to

£600m in the medium-term.

one of Debenhams’ other focuses

is to develop its mobile strategy.

An investigation conducted by the

company showed that in 2012,

27% of all the store visits were

from mobile devices, which is

higher than the industry average

of 15%. In the first half of 2013,

Debenhams’ mobile phone sales

increased by 265% in comparison

with 2012 (Internet Retailing,

2013).

First objective Second objective Third objective


Expanding the brand interna-tionally

Debenhams (2012) believes

that opening franchise stores is

a “low-cost, low-capital” way to

expand the brand in distant and

emerging markets. In 2012, De-

benhams entered two new mar-

kets of Russia and Pakistan and

they further opened new stores

in India, the Philippines and Iran.

In 2013, they plan on opening

new stores and entering new

markets.

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

32.14% increase in sales in 2011,

has been performing well and

has increased margins. This has

been achieved through Deben-

hams own brands and Magasin’s

branded volume lines. The Irish

segment, which has suffered in

the previous years due to the

volatile economic environment

is expected to stabilise. Table 2

indicates that although Ireland

had negative growth in sales

every year, it also showed signs of

recovery.

Debenhams (2012) has further

noted that there has been expan-

sion in their international online

retail. Their strategy is said to

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 oc-

cur in local currency. The smaller

markets however, will have to

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 Debenhams.com

has increased from 7 to 66. They

further plan on expanding in 30

more countries.

Fourth objective


Distinctive Capabilities

In a world with an ever so com-

petitive business environment, it

is not surprising that many firms

have attempted to create distinc-

tive capabilities in the pursuit

of competitive advantages. Kay

(1993) identified these distinc-

tive capabilities as architecture,

reputation, and innovation.

Architecture

Kay (1993) identified architec-

ture as one of the main sourc-

es of distinctive capability. He

explained that the companies,

which have created “organiza-

tional knowledge and routines”

and as a result enhanced the flex-

ibility of the business by sharing

and exchanging information in

volatile circumstances have cre-

ated valuable architecture.

An architecture which adds value

to the firm is the result of rela-

tional contracts. These contracts

are implicit and in contrast with

the classical ones do not have

each and every expectation and

responsibility written in the

terms of the contract.

“Architecture therefore de-

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).

Internal

Employees

External

Suppliers & Customers

ARCHITECTURE

Networks

Collaborating Firms

Figure 30. Corporate Architecture Structure by Kay (1993)

2.5 Debenhams’ Competitive Advantages


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 envi-

ronment. They have done this not

by employing the most talented

employees, rather by utilizing

ordinary employees in achieving

extra-ordinary performance. This

has been the result of creating

organizational knowledge and

routines and setting a co-opera-

tive ethic (Kay, 1993).

Debenhams is a large enterprise

with over 30,000 employees.

Creating and sustaining a co-op-

erative ethic in such a large or-

ganization, especially one which

is based on deep relationships2 is

often a challenging task. In order

for an organization to sustain

such co-operation, there should

be a sense of common purpose

and goal among all employees

(Kay, 1993).

Debenhams has adopted certain

strategies within the organiza-

tion with the aim of creating a

sense of common purpose among

its employees and promoting or-

ganizational knowledge, as well

as individualistic excellence. The

points in figure 31 outline the

nature of the relationship of De-

benhams with its employees and

overview the schemes and plans

developed by the management,

which aim at improving the over-

all performance of the company.

It is clear that Debenhams en-

courages both team work and

individual perfectionism by the

means of incentive schemes and

personal development plans.

They have created a consummate

co-operative ethic by acknowl-

edging employees that their

opinions matter and influence

the strategic direction of the firm.

Debenhams further condemns

opportunistic behaviour by hav-

ing set a business code of conduct

and promoting whistle-blowing

against unethical behaviour.

The information regarding De-

benhams’ internal architecture

was mainly retrieved from sourc-

es published by Debenhams and

therefore, it is somewhat biased.

Reviews by former employees

of the company revealed that

although Debenhams has es-

tablished the above strategies,

they may have not been able to

implement them as efficiently as

possible. A sample of 28 former

employees rated Debenhams

2.9 out 5 stars, while the former

employees of Marks & Spencer

gave M&S a rating of 3.4 stars.

Furthermore, while 82% of re-

viewers recommended M&S as

a desirable work environment,

only 52% recommended Deben-

hams (glass Door, 2013).

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


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

Figure 31. Debenhams’ Employee Scheme

good performance of the teams and individuals are rewarded through employee recognition scheme and cash. In 2008, the company devel-oped the Share Incentive Plan, which is an unapproved plan operated by the company, directed towards the company’s senior managers

Debenhams’ personal development plan, allows any employee to grow their careers. According to Debenhams in 2011, 89% of retail manag-ers and 69% of senior executives were appointed internally

Debenhams values the opinion of its employees and the senior man-agement team is obliged to “listen and act on feedbacks” (Debenhams Annual Report, 2012).

employees are encouraged to express their talents. This is a good in-dication 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.

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 per-formance, and by recognizing the teams and individuals who contrib-uted to this success.

In order to confront opportunistic behaviour, Debenhams has devel-oped “the code of business conduct” and the “anti-bribery and corrup-tion policy”. It encourages its employees to report acts of unethical be-haviour by any individual.

Debenhams enables its employees to invest in their future by giving access to defined contribution pension scheme with Legal & General.

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

Rewards & Incentives

Growth Opportunities

Valuing Opinions

Recognition of Talents

A Sense of Common Purpose

Opportunistic Behaviour

Pension Schemes

Other Benefits


Debenhams’ External . Architecture

The external architecture of

Debenhams concerns its rela-

tionships with its suppliers and

customers.

“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

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 particu-

larly valuable in fashion retailing,

where the needs of the customers

changes frequently and there is

“strategic posturing by both par-

ties” (Kay, 1993).

A firm to sustain its architecture

needs to create long-standing re-

lationships. Debenhams has been

direct sourcing for a long time en-

abling it to create long-standing

relationships with its suppliers

around the globe.

Access to large number of sup-

pliers in different regions of the

world and long-standing rela-

tionships with them has enabled

Debenhams to share product

knowledge more flexibly and stay

aware of changes in the custom-

ers’ fashion tastes in different

areas of the world. Hence, the

sourcing strategy of Debenhams

based on the “right product, right

country” slogan, combined with

its relational contracts with the

suppliers has been translated

into an effective external archi-

tecture. Debenhams believes

that long-standing relationships

with the suppliers would further

allow the company to improve

the management of input costs.

Furthermore, these relationships

mutually benefit both parties as

they both have the goal of “opti-

mising sustainable fulfilment and

costs” (Annual Report, 2012).

unfortunately, in 2013, Deben-

hams was criticized for “bullying”

its suppliers and forcing them to

cut prices by 2%. Furthermore,

there have been reports that De-

benhams was taking advantage of

some of its suppliers by delaying

payments up to 120 days instead

of 90. If such opportunistic acts

are continued by Debenhams, it

could result in the destruction of

its long-standing relationships

with the suppliers, which would

adversely affect the company’s

performance (loveless & Craven,

2013).


With regards to the relationship

with customers, Debenhams

has been improving its ability in

meeting the demands of the local

markets by offering more flexible

ways of shopping (through mul-

ti-channel) and by responding

fast to any changes in the tastes of

the consumers through enhanced

communications. Debenhams has

been able to increase online sale

by 265% from 2012 to 2013.

Networks

A group of businesses, which

have created relational contracts

with one another are referred as

networks. There are 26 interna-

tional designer brands that are

sold by the Debenhams stores

across several countries. They

have created relational contracts

with these designers with the

aim of better understanding the

demands of the local markets and

improving their product knowl-

edge. Fast response times be-

tween these collaborating stores

has allowed all parties to improve

performance.

Figure 33. Direct Sourcing (Source: Debenham’s Annual Report, 2012)


Reputation

Kay (1993) regarded reputation

as the second source of distinc-

tive capability. Reputation is the

mean by which information about

a business is transferred to the

consumers. Reputation is of high

value in the markets where the

quality of products is important

and can only be realized over a

long period of experiencing those

products. Debenhams has been in

existence for over two centuries

and its ability in sustaining the

business over such a long period

may have had a positive impact

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 past decade. It has expand-

ed the business considerably

in the recent years by opening

new stores and franchises in the

different regions of the world. It

has further introduced many new

designers to the business and has

increased marketing and adver-

tising in multichannel. All these

changes appear to have had pos-

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

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


itive impacts on the company’s

reputation. The introduction of

diverse selection of Debenhams’

own brands, uK brands and inter-

nationally recognized designers

has improved Debenhams’ repu-

tation for “contemporary quality

fashion and furnishing (Best-CD-

Price Shopping, 2013).”

Furthermore, Debenhams’ “profit

scare” in the first half of 2013, which

caused its share prices decline rap-

idly, did not change the perception

of consumers on Debenhams’ repu-

tation. The yougov brand index in-

dicated that the brand perception of

Debenhams for its quality and value

has remained stable in the past few

years. This shows that Debenhams

has been able to sustain its repu-

tation in a rather volatile market

environment.

Debenhams has established a sys-

tematic approach of identifying, as-

sessing, analysing and managing the

risks the company faces on a day to

day basis that could adversely affect

its reputation and cause a loss of

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)


Innovation

Innovation is usually considered

as a source of competitive advan-

tage, only when it is accompanied

by other distinctive capabilities.

Kay (1993) noted that often

times the rewards of the architec-

ture of a company are mistakenly

credited to innovation.

In recent years, Debenhams expe-

rienced high levels of innovation

and development in e-commerce

and multi-channel. In September

2011, Debenhams claimed that

it had developed an innovative

smart-phone technology by

which printed advertisements

were brought to life3. They fur-

ther launched a virtual shopping

innovation, which allows custom-

ers to “try on” range of clothing

in an augmented reality, simply

by downloading an application

(MacDonald, 2013).

At a recent presentation in lon-

don, Debenhams’ head of digital

operations discussed the recent

innovations of the company in

e-commerce and multi-channel

and its effects on the company’s

performance. Debenhams has

developed what is referred as

an “agency like” innovation. This

new approach adopted by the

company, is simply the means of

testing a new product or technol-

ogy in a small scale before devel-

oping it further. This has enabled

the company to develop new

technology and innovation at half

the previous time scale. However,

this approach has resulted in the

fragmentation of the company’s

architecture and the enhance-

ment in the innovation in the past

few years has been somewhat at

the cost of the company’s flexibil-

ity. (Payne, 2012)

Strategic Assets

The strategic assets of a firm, as de-

scribed by Kay (1993) are sources

of competitive advantage, which

concern the company’s dominance

or market position as opposed

to its distinctive capabilities. De-

benhams’ strategic assets in 2012

included the acquisition of licenses

and trademarks for a total value of

£7.2 million. Furthermore, Deben-

hams has incurred expenses on the

marketing and advertising division

of the business. Debenhams has

also invested over £5m on mul-

ti-channel and e-commerce, which

have allowed it to capture a larger

portion of the market. Finally, their

ability in opening and operating

75,000 square feet department

stores has enabled to increase

economies of scale and operate

more cost effectively.

All these strategic assets to some

extent act as barriers to entry, as

Debenhams as an incumbent has

incurred sunk costs, which need to

be made by entrants who are aim-

ing at capturing some share of the

market. The size of Debenhams, its

economies of scale and the compa-

ny’s large investments in acquiring

licenses and capturing market

share all may deter entry.

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


In order for a company to take

full advantage of its distinctive

capabilities, it needs to choose

the appropriate markets. This is

an issue, which is often faced by

companies, as the market choice

needs to be made by taking both

the geographical and product

dimensions into consideration.

For distinctive capabilities such

as reputation and architecture,

the appropriate market is iden-

tified by the “nature of demand

for that product” (Kay, 1993). For

innovation on the other hand, the

“technical characteristics of the

product” determines the appro-

priate markets in which innova-

tion translates into a competitive

advantage.

While supply factors define the

industry, the markets are defined

by demand. Debenhams, which

once was a part of the Burton

group has been known for de-

fining its target market rather

too broadly. Debenhams has

been aiming at individuals of all

ages and both sexes. The figure

below shows the segments of the

market targeted by Debenhams

in comparison to some other uK

stores. The Burton group has

targeted a much smaller segment

of the market. In fact, their main

objective in the past few decades

has been targeting a specific,

single gender market. In 1980s,

The Burton Group started defin-

ing segments for the market and

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

profiling their customers. They

found this to be a more efficient

way of running the stores. By

1993, apart from the Debenhams

department stores (which at the

time were a part of the Burton

group), all Burton shops targeted

a specific segment (Irwin, 1998).

This was the main reason that the

Burton group de-merged from

Debenhams, as they believed

Debenhams defined their target

markets too widely. The main de-

mand for Debenhams’ products

is by males and females of 33 to

55 years of age, who are not nec-

essarily interested in designer

labels, but do respond to brand

names (Koenig, 2013).

Even though it is often difficult

to extend reputation outside the

geographical region in which the

market was created, Debenhams

has opened stores and franchises

in other areas of the world. This

however, could be due to econ-

omies of scale, as a firm with a

competitive advantage in one

market could benefit from serv-

ing other markets even if it does

not have competitive advantages

in those markets.

2.6 Debenhams’ Market Choices


This section of the report analy-

ses Debenhams from a financial

perspective. It attempts to de-

termine whether the company’s

performance is in line with its

“stated goals and strategies” (Pa-

lepu, Healy, &Peek, 2010).

A company’s performance can

extensively be examined by

conducting Ratio and Cash flow

analysis. Ratio analysis examines

the relationship between the

various line items of Debenhams’

financial statements, while the

Cash flow analysis on the other

hand attempts to assess Deben-

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

company’s overall performance.

Finally, some other financial

measures will aid understanding

the company’s health, credit wor-

thiness and its ability in sustain-

ing long run profitability.

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

text. A discussion of the impor-

tant accounting policies adopted

by the companies can be found in

the appendices.

FINA

NCI

AL A

NALY

SIS

3.1 Introduction


In order to make the analyses

more accurate and the compa-

nies more comparable, some

adjustments need to be made.

Fortunately, Debenhams’ peers

operate in the united Kingdom

and have all adopted the IFRS

and the company act 2006; as a

result no adjustments are needed

to converge from one standard to

another4. However, some items

on the financial statements re-

quired adjustments.

Goodwill

Although goodwill is not amor-

tized in the income statement,

tests are carried out annually to

determine whether it has been

impaired. If the goodwill is in-

deed 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

performance in the periods after

the write down. Thus:

• goodwill has been complete-

ly eliminated in performing

the analysis

• goodwill impairment charg-

es have also been removed

from the income statement

Nonrecurring Items

Nonrecurring items have been

excluded from the analysis as

they are one-off in nature and

distort the analysis. These are

items such as profit and loss on

the disposal of properties, im-

pairment of assets and fair value

adjustments to financial instru-

ments.

Inventory Valuation

Although three of the companies

use the retail method in deriving

their costs of goods sold, the N

Brown group uses the FIFo meth-

od of inventory valuation. Con-

verting this method of inventory

valuation to that of its peers may

aid the analysis, however due to

the limitation of this report, no

adjustments were made.

3.2 Accounting Adjustments

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 discrep-ancies between the treatment of items such as finance income in producing cash flow statements and these distortions require adjustments.


Common-size statements nor-

malise the balance sheets and

income statements, and provide

information that are more easily

comparable across firms as well

as for a single firm over time.

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

the complex nature of the com-

mon-size balance sheets and the

confusions that they may cause

in comprehending the analyses,

only the common-size income

statements have been produced

in this section.

Vertical Trend Analysis

The vertical common-size analy-

sis of Debenhams’ consolidated

income statements attempts to

determine the company’s perfor-

mance in the past five years. The

vertical common-size income

statements express each line item

as a percentage of the company’s

total revenue. In 2010, there were

a total of £5.4m exceptional costs

that were deducted from the

operating profit. Due to non-re-

curring nature of these expenses,

they were added back to the net

income and the operating profit

figures.

3.3 Debenhams’ Common - Size Trend Analysis

Table 5. Debenhams’ Vertical Common-Size Income Statement


Financial ratios such as the gross

profit, operating profit and net

profit margins have been cap-

tured by the vertical analysis.

Firstly, it is evident that the items

on the common-size income

statements remained rather sta-

ble. Furthermore, even though

the net profit margin has been

increasing consistently, the oper-

ating profit and the gross profit

margins gradually decreased

over the five year period. Further

analysis of the common–size in-

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

2008 to 2012, the net finance

costs decreased more rapidly by

3.07%, reducing this ratio from

3.82% to 0.75%. Figure 39 indi-

cates that the most substantial

change has occurred in the com-

pany’s net finance costs.

Gross Profit MarginOperating Profit MarginNet Profit Margin

Gross Profit MarginOperating Profit MarginNet Profit MarginNet Finance Costs (%)

Figure 38. Profitability Ratios Figure 39. Vertical Analysis


Table 6. Debenhams’ Horizontal Common-Size Income Statement

Horizontal Trend and Cross-sectional Analysis

Horizontal common-size analysis

is similar to vertical with the dif-

ference that the divisors are the

first years items of Debenhams’

income statements. In this sec-

tion cross-sectional common-size

analysis has also been conducted.

The main competitors of De-

benhams are Marks & Spencer,

House of Fraser and John lewis

Partnership, of which only Marks

& Spencer is a public compa-

ny. unfortunately, performing

a cross-sectional analysis with

only Marks & Spencer identified

as a competitor is rather biased.

As a result, a thorough research

revealed that Ted Baker and N

Brown group are also considered

Debenhams’ peers.

Debenhams’ gross profit has re-

mained rather stable in the past

five years. Furthermore, although

the company’s distribution costs

have increased by 1.6 times its

value in 2008, the operating

profit has remained almost un-

changed. Finally, the net finance

costs have decreased significant-

ly and the net profit attributable

to shareholders had a steady

growth in these five years.

When the vertical common-size

income statements were pro-

duced, cross-sectional analysis

was not conducted. This is be-

cause the main ratios captured by

the vertical analysis (e.g. net prof-

it margin) have all been analysed

extensively in the ratio analysis

section of this report. However,

for identifying the trends of rev-

enue, operating profit and net

profit across all the firms, the

horizontal trend analysis is of

high value, as it shows the move-

ment of these items regardless of

the sizes of the companies.


2008

1.01.01.01.0

DebenhamsM&S

N Brown groupTed Baker

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.02009

1.01.01.11.1

2010

1.21.01.11.2

2011

1.21.11.21.3

2012

1.21.11.21.5

2008

1.01.01.01.0

DebenhamsM&S


1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.02009

1.00.71.00.9

2010

1.10.81.10.9

2011

1.00.81.11.1

2012

1.00.71.11.2

Figure 40. Revenue

Figure 42. Net Profit

Figure 41. Operating Profit

2008

1.01.01.01.0

DebenhamsM&S


1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.02009

1.01.01.11.1

2010

1.21.01.11.2

2011

1.21.11.21.3

2012

1.21.11.21.5


From figure 40 it is evident that

apart from Ted Baker, which expe-

rienced a 50% growth in sales, all

other companies increased reve-

nue by only a margin of 10 – 20%.

later on, when the share prices of

these companies are analysed, it

will be shown that the movements

of their share prices appear to be

somewhat correlated with the

growth of their sales.

Marks & Spencer’s operating profit

fell by 30% in five years. However,

the largest drop occurred in 2009

where it fell by 30%. Ted Baker

also experienced a 20% drop in the

same year, but this drop was later

on reversed and by 2012 Ted Baker

took the lead. Finally, it is evident

that the growths in the operating

profits of Debenhams and N brown

group remained rather stable in

these five years. The stable operat-

ing profit of Debenhams along with

its increased revenue inidcates

that the company’s operating costs

have increased in this period.

Figure 42 shows the net profit

growth of the four companies. De-

benhams had a consistent growth

in net profit and grew to 160% of

its value in 2008. This growth in

Debenhams’ net profit, which has

been much higher than its peers

has been due to the company’s

ability in reducing finance costs.

In conducting the analysis adjust-

ments were made to the net prof-

its and the operating profits of N

Brown group, Ted Baker and Marks

& Spencer. These adjustments

were made due to the existence

of some non-recurring expenses

on the companies’ accounts, such

as exceptional items, profit and

loss from disposal of assets, fair

value adjustments, and non-gAAP

adjustments. Apart from some of

the exceptional costs incurred by

Marks & Spencer, many of these

expenses did not have any material

impacts on the analysis. An exam-

ple is as shown below.

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


3.4 Time - Series Ratio Analysis

The value of a firm is determined

by its growth and profitability

achieved by quality operational

management, investment man-

agement, financial strategy and

dividend policy (Palepu et al,

2010).

Ratio analysis attempts to deter-

mine whether the policies and

the strategies implemented by

Debenhams in the past five years

have been effective in creating a

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 company’s performance.

Profitability

Profitability ratios are of high

importance and are regularly

watched by investors. The value

of the firms and their stock prices

are affected almost immediately

by unexpected changes to these

ratios. The main ratios for profit-

ability include the net profit mar-

gin, gross profit margin, return

on capital employed and return

on shareholder’s equity (Cornett

et al, 2012).

The net profit margin shows the

percentage of the sales remain-

ing after all expenses have been

deducted. This ratio is affected

by consumers, industry and the

general economic climate.

The net profit margin of Deben-

hams has increased in the past

five years. The trend has been

generally upward (with an insig-

nificant drop in 2010) and over

a five year period this ratio had

increased by about 2%. As it was

shown earlier, the operating prof-

it margin had a downward trend.

Therefore, the underlying reason

for this increase is the rapid drop

in financing costs.

2008 2009 2010 2011 20124.19%

14.55%17.32%61.53%

4.96%13.83%18.71%34.54%

4.82%13.70%23.57%21.99%

5.30%13.43%25.37%20.15%

5.62%13.56%19.29%18.98%

Net Profit MarginGross Profit Margin

RoCeRoe

Table 7. Debenhams’ Profitability Ratios

2008

%

6

5

4

3

2

1

0

2009 2010 2011 2012

Figure 44. Net Profit Margin


The Gross profit margin relates

gross profits to the sales. This

ratio is specifically of high value

to retailers who desire to know

how much the company profits

by buying and selling, before any

other costs have been taken into

account. Debenhams’ gross profit

margin has dropped by about 1%

in the past five years, which tells

of its stability.

Return on capital employed is a

major financial ratio in determin-

ing Debenhams’ profitability as it

indicates whether the company

has been able to generate profits

using the capital that it had em-

ployed. The capital employed by

a company includes long term in-

terest-bearing debt and the total

shareholder’s equity, which has

been adjusted for any distortions.

In comparison to the previous

two ratios, the RoCe experienced

significant changes. The return

on capital employed increased by

about 10% from 2008 to 2011,

before dropping in the year 2012.

Figure 47 reveals that the vola-

tility of RoCe has been due to a

rapid increase of operating profit

2008

%

30

25

20

15

10

5

02009 2010 2011 2012

Figure 47. Capital Employed and Operating Profit

Figure 46. ROCE

Figure 45. Gross Profit Margin

2008

%

14.6

14.4

14.2

14

13.8

13.6

13.4

13.2

132009 2010 2011 2012

2008

£m

1200

1000

800

600

400

200

0

£m200195190185180175170165160

2009 2010 2011 2012

Capital employedOperating Profit


in the years 2008 to 2010, which

was later followed by a sudden

decline.

Return on equity shows the re-

turn to the company’s investors

and the common equity share-

holders. Shareholders have in-

vested in the company’s assets

and need to know whether they

are getting any returns from their

investments. In short, this ratio

shows the relationship between

the net profit and the sharehold-

ers’ funds. The return on compa-

ny’s common equity has dropped

rather rapidly in the past five

years. In 2008, the return on

equity was 60% and by 2012 it

dropped to about 20%.

Management Efficiency

Asset management ratios at-

tempt to determine how effi-

ciently Debenhams has used

its assets. They further aim at

analysing Debenhams efficiency

in managing its accounts payable

(Cornett et al, 2012). Asset and

the inventory turnover ratios are

two important ratios in analysing

the efficiency of companies with-

in the retail industry. The inven-

tory turnover ratio determines

how many pounds of sales were

produced by one pound of inven-

tory (Cornett et al, 2012). The

asset turnover ratio is similar

to the inventory turnover ratio,

with the difference that instead

of the inventory, the assets of the

company are taken into consid-

eration. The inventory turnover

trend in the past five years has

been downwards; nevertheless

this change has not been signifi-

cant. The asset turnover ratio had

increased slightly by 2011, before

experiencing a drop in 2012.

Average inventory turnover

period measures the number

of days that the company holds

the inventory before selling it to

the customers. It is in the best

interest of the company to have

a low figure for this ratio, as it

is an indication of quality inven-

tory management (Cornett et al,

2012). The trend in the average

inventory turnover period has

been upwards, which could mean

that the company’s inventory

management has deteriorated in

the past five years. However, it is

important to highlight that a very

small figure is not necessarily a

good sign, and is often considered

a red flag, as it may mean that the

company does not have sufficient

inventory (Cornett et al, 2012).

Trade receivables collection pe-

riod measures the length of time

2008

%

70

60

50

40

30

20

10

02009 2010 2011 2012

Figure 48. ROE


that takes the company to collect

its accounts receivable. A low fig-

ure is preferred as the company

should attempt to collect receiv-

ables as fast as possible in order

to reduce its financing costs. It

is evident that this figure has

remained unchanged in the past

five years. A very small figure

for the average collection period

could simply mean that the com-

pany has a very strict receivable

policy, which may result in cus-

tomers buying products from

competing firms.

The trade payables settlement pe-

riod is the length of time it takes

the company to pay its creditors.

The management often prefers

the company to pay its account

payable as slowly as possible.

This is because the company will

be able to delay obtaining higher

cost sources of financing (Cornett

et al, 2012). This measure has de-

2008 2009 2010 2011 20125512

109-42

5612

103-34

561295-26

591294-23

621296-22

(in days)Average inventory turnover periodTrade receivables collection periodTrade payables settlement period

Cash conversion cycle

Table 8. Debenhams’ Management Efficiency Ratios

2008

1.81

6.62

Asset turnover ratio

Inventory turn-over ratio

x

7

6

5

4

3

2

1

02009

1.97

6.49

2010

2.56

6.46

2011

3.05

6.21

2012

2.46

5.90

2008

days

64

62

60

58

56

54

52

502009 2010 2011 2012

Figure 49. Average Inventory Turnover Period

Figure 50. Asset and Inventory Turnover Ratios


2008

days

115

110

105

100

95

90

852009 2010 2011 2012

2008

days

-15

-20

-25

-30

-35

-40

-45

2009 2010 2011 2012

Figure 51. Trade Payables Settlement Period Figure 52. Cash Conversion Cycle

creased by about 15 days in the

past five years (see fig. 51). There

were however signs of improve-

ment in 2012. A very high figure

could be due to the company

abusing its credit terms, which

could result in suppliers revoking

the company’s ability in purchas-

ing on an account (Cornett et al,

2012).

All the above measures are useful

in deriving what is referred to as

the cash conversion cycle, which

is a measure of the company’s

liquidity and is also useful in un-

derstanding the company’s effi-

ciency in managing its inventory,

accounts receivable and accounts

payable.

Debenhams’ cash conversion

cycle is negative, which is an in-

dication of quality management.

However, it is important to high-

light that negative cash cycles are

not sustainable in the long run,

which explains its increase in the

past five years. This is because a

negative cash cycle implies that

the suppliers are paid only after

all collections have been made

from the customers.

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 av-

erage inventory turnover period

appears to have deteriorated in

these years. These in turn have

increased Debenhams’ cash con-

version cycle.


Figure 53. Liquidity Ratios

2008

0.540.160.07

Current Ratio Quick Ratio

Cash Ratio

x0.90.80.70.60.50.40.30.20.1

02009

0.880.420.31

2010

0.410.130.06

2011

0.590.140.04

2012

0.630.160.06

Liquidity

liquidity ratios measure the

company’s ability in meeting

its short term obligations. They

attempt to determine the rela-

tionship between the company’s

current assets and current lia-

bilities (Cornett et al, 2012). In

the previous section, the cash

conversion cycle revealed that

the company’s liquidity has been

decreasing in the past five years.

However some other ratios will

better aid understanding the

trend in the company’s liquidity.

The first ratio analysed in this

section is the current ratio, which

is the broadest of all liquidity

measures, as it includes all the

company’s current assets. Quick

ratio is another measure for eval-

uating the firm’s liquidity, which

excludes inventories5 from the

current assets and as a result

give a better view of the com-

pany’s liquidity. Finally the cash

ratio measures liquidity by only

including cash and marketable

securities, which are the most

liquid assets of the company.

5 The least liquid of current assets

All three ratios indicate that De-

benhams’ liquidity increased sig-

nificantly in the year 2009, which

was followed by a major drop in

the 2010 (see fig. 53). The trend

following the year 2010 was

stable without any significant

changes in the cash and quick

ratio. However, the current ratio

increased from 0.4 to 0.6 before

experiencing only a marginal

growth in 2012. The most im-

portant issue to consider is that

all ratios are below 1.0, which

means that Debenhams does not

have enough current assets to

meet its short-term obligations.

It is important to note that even

though high levels of liquidity

guard the company against li-

quidity crises, they come at the

cost of lower profits. This is be-

cause liquid assets do not gener-

ate much revenue for the compa-

ny. Higher levels of liquidity could

be a major signal of inefficient

management of the firm.


2008

x16141210

86420

x0.50.450.40.350.30.250.20.150.10.050

2009 2010 2011 2012Cash coverage ratioInterest coverage ratioCash generated from opera-tions to maturing obligations

2008 2009 2010 2011 20120.441.932.74

0.391.892.73

0.282.214.23

0.372.667.84

0.363.45

14.62

Cash generated from operations to maturing obligationCash coverage Ratio

Interest Coverage Ratio

Table 9. Debenhams’ Analysis of Liquidity Using Cash Flow Ratios

Some other measures for exam-

ining the liquidity are cash flow

ratios. Since cash flow statements

are not prone to manipulations,

cash flow ratios are very popular

among analysts, as they are more

reliable. Therefore, to get a better

view of the company’s liquidity,

a few other ratios have been an-

alysed.

The cash coverage and the in-

terest coverage ratios have in-

creased in the past five years.

Specifically, the interest coverage

ratio has grown significantly in

these years and this has been

mainly due to the reduced cost of

financing of Debenhams.

Capital Structure and Debt Management

This section analyses Debenhams

capital structure, in order to give

an understanding of the extent

to which the company has been

financed with debt. The capital

structure employed by Deben-

hams’ 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

to provide higher cash flows to

its stockholders; however, this

increase in cash flows may come

at the cost of company’s bank-

ruptcy. often companies in the

industries, which are not very

profitable, are the ones that have

been financed with high levels of

debt.

In order to analyse Debenhams’

capital structure, the trend in the

levels of the company’s total debt

and its total shareholder’s equity

have been examined as shown in

figure 56. Only long and short-

term interest bearing debts were

included in the calculation of the

total debt.

Figure 54. Cash Flow Analysis of Liquidity


Total DebtTotal equity

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

Debenhams had the highest level

of debt financing in 2008. Follow-

ing this year the company became

less geared and the level of total

shareholder’s equity increased.

As it was shown earlier, the fi-

nancing costs of Debenhams de-

creased dramatically in the past

few years, which can be credited

to the decrease in the company’s

levels of debt. Furthermore, the

underlying reason for growth in

shareholder’s equity is the de-

crease of the negative retained

earnings of the company and the

increase in its merger reserves.

2008

£m

1200

1000

800

600

400

200

02009 2010 2011 2012

Figure 56. Capital Structure


2008 2009 2010 2011 201287.68%

2.3561.73%

2.917.46%3.45

27.05%6.73

27.39%9.78

gearing RatioInterest Coverage Ratio

Table 10. Debenhams’ Debt Management Ratios

2008

75176.1

Finance costs Operating profit

£m250

200

150

100

50

02009

62.7182.2

2010

56.5195.1

2011

27.3183.7

2012

17.9175

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

coverage ratio increased from

2.35 to 9.78. This means that in

2012 for each pound of interest

payment there has been 9.78

pounds of operating profit avail-

able to cover the interest obli-

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

profit remained stable in the

years of the analysis.

Market Value Ratios

In order to determine whether

Debenhams’ share prices reflects

the market’s view on the compa-

ny’s future profitability, market

value ratios have been used. An

important ratio to investors is

the return on equity; however,

return on equity does not show

the increased risks that may be

embedded in higher returns. For

instance, the company may be

highly geared and the high re-

turns may arise from increased

levels of debt financing. This in-

formation can be easily observed

in the firm’s market prices, as

they are a reflection of the mar-

ket’s view on the company’s fu-

ture performance.

Figure 58 shows the share price

performance of Debenhams from

September 2008. In 2008 the

share prices were at their lowest

range, having hit figures as low as

20 pence per share. This decrease

Figure 57. Operating Profit and Finance Costs


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

in prices has been mainly due the

increased level of investors’ risk

aversion following the financial

crisis and their reluctance in

taking positions in cyclical firms

such as Debenhams. In 2009, the

prices increased significantly to

about 100 pence per share and

from that date until 2012 the

share prices experienced a mod-

erate downward trend. Following

the year 2012, Debenhams’ share

prices increased significantly,

reaching a peak price of 120

pence per share before dropping

to a support level of 80 pence.

generally the increase in Deben-

hams’ share prices in 2012 shows

the market’s positive sentiment

regarding the future profitability

of Debenhams. This increase is

also somewhat correlated with

the positive economic growth

forecasts. However, a “profit

scare” report that was released in

March 2013, led into the decline

of the share prices. An analysis

conducted by yougov, indicat-

ed that the profit scare had not

changed the consumers’ percep-

tion on Debenhams, and hence,

an upward trend in share prices

ensued.


2008 2009 2010 2011 20129

4.6317.20%

107.27

0.48%

7.57.16

0.00%

9.15.33

2.76%

9.89.69

4.11%

EPS(pence)P/E

Dividend yield

Table 11. Investor Ratios

2008

12

10

8

6

4

2

02009 2010 2011 2012

2008

m

1400

1200

1000

800

600

400

200

0

£m

140

120

100

80

60

40

20

02009 2010 2011 2012

Shares outstandingNet income

Debenhams’ ePS has been rela-

tively stable in the past five years

with the exception of a decrease

in 2010. The stability of ePS has

been due to the consistency of the

growth in the net income and the

number of shares outstanding

(see fig. 61). The reason for the

ePS drop in 2010 lies behind the

disproportionate growth of these

two items.

The price-earnings ratio relates

the market price of a stock to the

earnings per share of the com-

pany. This ratio measures the

amount investors are willing to

pay for each pound that Deben-

hams earns per each share of its

stock (Cornett et al, 2012). Figure

60 shows a rather volatile Pe

ratio for Debenhams in the past Figure 61. Shares Outstanding and Net Income

2008

12

10

8

6

4

2

02009 2010 2011 2012

Pence Figure 59. EPS

Figure 60. P/E


2008

%1816141210

86420

2009 2010 2011 2012

five years. However in 2012 there

has been a significant increase

in this measure, which reflects a

generally positive sentiment to-

wards the future profitability of

the company.

Dividend yield shows the cash

flow returns on investments on

Debenhams’ stock. It is a useful

measure in analysing the amount

of cash flow an investor receives

for purchasing a stock. Deben-

hams’ dividend yield decreased

significantly in 2009, dropping

from 17.20% in 2008 to 0.48% in

2009. The author believes there

have been two contributing fac-

tors, which led to this decrease.

Figure 62. Dividend Yield

• The first reason may have

been the company’s expan-

sion into Denmark and the

acquisition of Magasin du

Nord in 2009. Many firms

that are in a stage of growth

do not pay dividends; rather

they reinvest the capital in

the business.

• The second reason may have

been due to the company’s

large negative retained earn-

ings in 2008 and 2009. An

explanation may be that fol-

lowing the financial crisis the

company decided to recover

its losses, as opposed to pay-

ing dividends.

Du-Pont Analysis

In the profitability sections it was

shown that in the past five years

Debenhams’ Roe declined expo-

nentially. Due to the importance

of Roe, the Du-Pont Corporation

invented a method by which the

Roe was broken down into three

to five components, and each

component was analysed individ-

ually. The Du-Pont Corporation

established that the Roe is a

product of the net profit margin,

total assets turnover and the eq-

uity multiplier ratios.

The return on equity is broken

down into three components,

each of which measures the

company’s profitability, manage-

ment efficiency and its capital

structure. Table 12 shows that

the company’s profitability and

management efficiency have

remained rather stable in the

previous years. The component

which led Debenhams in having

a high ROE of 61.53% in 2008,

and then decrease exponentially

over five years to 18.98%, has

been the decrease in the equity

multiplier, which is a measure of

leverage. This is consistent with

the previous findings, which

showed that although in 2008

Debenhams was highly geared,

the debt financing was decreased

significantly by 2012.

2008 2009 2010 2011 20124.19%

1.818.12

61.53%

4.96%1.973.54

34.54%

4.82%2.561.78

21.99%

5.30%3.051.25

20.15%

5.62%2.461.37

18.98%

Net Profit MarginTotal Asset Turnover

Equity MultiplierROE

Table 12. Du-Pont Analysis


In the previous section, time-se-

ries ratio analysis of Debenhams,

aided to some extent the un-

derstanding of its performance

over a five year period. However,

time-series analysis on its own

only gives a limited picture of the

company’s performance. There-

fore, conducting cross-sectional

analysis is necessary for obtain-

ing a more precise image of the

company’s financial health.

The aim of cross-sectional anal-

ysis is to compare the perfor-

mance of Debenhams with “sim-

ilar companies, which compete in

the 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 au-

thor has used his best judgement

in choosing suitable companies

for conducting the analysis.

3.5 Cross - Sectional Ratio Analysis

Profitability

According to the retail owner

institute (2013) a key ratio for

comparing the profitability of

companies that operate in the

retail industry is the Return on

Capital employed.

Ted Baker had a significantly

higher RoCe in comparison to

its peers. Furthermore, Deben-

hams’ profitability from 2009

to 2011 increased by about 5%,

while in comparison, its peers all

sustained a somewhat stationary

RoCe. By 2011, Debenhams had

already outperformed Marks &

Spencer and N Brown group.

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 & Spen-

cer.

2008

17.3227.9818.4239.74

DebenhamsM&S


%4540353025201510

50

2009

18.7118.9418.0732.15

2010

23.5719.4417.7131.98

2011

25.3718.2018.6633.93

2012

19.2918.3516.9633.60

Figure 63. Profitability (ROCE)



The inventory turnover ratio is

a suitable measure for assessing

the management efficiency of the

companies. This ratio has been

regarded as a key efficiency in-

dicator for firms operating in the

retail industry.

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

to inefficient management of the

inventories. Debenhams invento-

ry turnover ratio had remained

stable in the past five years and

furthermore, it is evident that in

comparison to its competitors,

this ratio not too high or too low.

2008

6.6211.324.012.03

DebenhamsM&S


2009

6.4911.104.501.90

2010

6.4610.304.961.80

2011

6.219.274.721.89

2012

5.909.044.411.77

Figure 64. Management Efficiency

12

10

8

6

4

2

0

x

2008

0.540.594.342.24

DebenhamsM&S


2009

0.880.604.861.93

2010

0.410.804.522.36

2011

0.590.743.352.14

2012

0.630.735.111.98

Figure 65. Liquidity6

5

4

3

2

1

0

x

Liquidity

The current ratio is the main

measure for examining the li-

quidity of the companies in the

retail industry.

As it is evident from the graph

below, both Marks & Spencer and

Debenhams are illiquid as their

current ratios are less than 1.0.

A current ratio of less than 1.0

indicates that the company will

not be able to meet its short-term

obligations should such obliga-

tions arise. Both N Brown and

Ted Baker appear to be very liq-

uid, however as discussed earlier,

high liquidity may come at the

cost of profitability, as liquid as-

sets do not generate much profit.


Capital Structure

For analysing the capital struc-

ture across firms, the gearing

ratio had been used. The graph

below indicates that Debenhams

had the most volatile gearing

ratio, whilst Marks & Spencer

and the N Brown group had only

fluctuated by a 10 - 12% margin

in the past five years. Debenhams

had the highest gearing ratio in

2008, however, by 2010 it be-

came the least geared company.

Ted Baker has been excluded

from the analysis, as it has no

long-term interest bearing debts.

Market Value Ratios

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

and Spencer have been similar

in the past five years. Ted Baker

on the other hand diverged from

the rest of the group in 2012 and

its share prices experienced a

relatively large growth in 2013.

Figure 68 further shows that De-

benhams has consistenlty been

able to outprform the general

retail industry in the five years of

the analysis.

2008

87.6849.6550.69

Debenhams M&S

N Brown group

%100

80

60

40

20

02009

61.7350.2148.82

2010

7.4651.0341.89

2011

27.0541.8134.52

2012

27.3941.2138.33

Figure 66. Capital Structure

2008

4.635.969.68

11.11

DebenhamsM&S


1816141210

86420

2009

7.276.657.29

10.39

2010

7.169.467.54

13.33

2011

5.338.759.19

14.71

2012

9.6910.257.51

17.02

Figure 67. Price to Earnings


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)

The P/e ratio trend shows that

Debenhams’ price to earnings

was lower than its peers in 2010

and 2011; however, this multiple

picked up significantly in 2012,

following the increase in Deben-

hams’ share prices from about

60 pence to over 100 pence per

share. Nevertheless, in 2013 the

company’s P/e ratio of 11.03 has

remained consistently below the

industry P/e ratio of 15.27.


3.6 Analysis of the Retail Specific Ratios

The cross-sectional and time-se-

ries analysis of Debenhams has

also been conducted using retail

specific ratios. While common fi-

nancial ratios are good measures

for understanding the overall

performance of the company,

the retail specific ratios attempt

to analyse some specific factors

which may have not been cap-

tured by the earlier analyses and

are important to the survival of

the retailers.

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 compa-

nies were used in conducting the

cross-sectional analysis.

Like for Like Sales

Figure 71 shows Debenhams’

trend in like fore likes and unad-

justed sales increase in the past

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 re-

sulted in artificially inflated sales.

It is evident that the like for like

sales of Debenhams and Marks

& Spencer have followed a some-

what similar trend. Both compa-

nies had negative trends in 2008

and 2009, which may have been

due the financial turmoil of 2008.

After 2009, they showed signs of

growth and by 2012 Debenhams

and N brown group reached the

same level of like for like sales.

It can generally be said that the

growth in Debenhams’ like for

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.

Figure 70. Like for Like Sales

2008

-0.9-0.512.5

Debenhams M&S

N Brown group

%15

10

5

0

-5

-102009

-3.6-5.910.7

2010

00.93.3

2011

-0.32.91.3

2012

1.60.31.6


Gross Margin Return on Inventory

This ratio shows the average re-

turn generated by the inventory

over its cost. A ratio of more than

1.0 is an indication that the com-

pany is selling its inventory more

than its cost. It is evident that

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

1.0. The competitors on the other

hand were able to generate re-

turns well above the cost of their

inventories.

Sales per Square Foot

This measure shows the manage-

ment’s efficiency in creating rev-

enue for each square foot of the

shop floor. Debenhams and Marks

& Spencer retained a stable ratio

during the five year period. On

the other hand, Ted Baker’s trend

in sales per square foot followed

a u shaped pattern.

2008

%1210

86420

-2-4-6

2009 2010 2011 2012

Figure 71. Sales Growth

2008

1.137.134.962.82

DebenhamsM&S


8

7

6

5

4

3

2

1

02009

1.046.585.112.68

2010

1.036.305.482.82

2011

0.965.745.513.05

2012

0.935.494.972.80

2008

171.82590.74912.62

Debenhams M&S

N Brown group

£100

80

60

40

20

02009

173.42547.94824.74

2010

170.97556.36778.10

2011

177.59559.81831.16

2012

178.08554.26895.40

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

Figure 73. Sales Per Square Foot

unadjusted growthlike for likes


3.7 Credit Worthiness and Distress Prediction

There are many reasons as to

why firms use debt as a source of

financing. Companies with high

rates of marginal tax find debt

financing very attractive, as they

are able to deduct the interest as

an ordinary business expense.

This source of financing further

motivates the company’s manage-

ment to create value for the firm,

which reduces conflicts of interest

between the shareholders and

managers. (Palepu, Healy, & Peek,

2010)

In order to analyse the credit wor-

thiness of Debenhams, it is im-

portant to evaluate the likelihood

of this company experiencing

financial distress. Analysing the

credit worthiness of a company,

simply by relying on a specific

model is naïve (Palepu, Healy, &

Peek, 2010). A thorough analysis

requires the assessment of the

company’s strategy, accounting

policies, financial ratios and some

other factors. Nevertheless, these

models aid the analysis by giving

an overall view on the company’s

probability of experiencing finan-

cial distress.

For analysing Debenhams’ finan-

cial health, the Taffler’s Z-Score

model, a popular model in pre-

dicting financial distress for UK

companies, has been used. In this

model four variables are assigned

weights and the sum of the prod-

ucts of each coefficient with its

corresponding variable produces

a unique Z value. If the Z-value de-

rived is less than zero, the model

predicts financial distress.

Z=3.2+12.18(X1 )+2.5(X2 )-10.68(X3 )+0.0289(X4 ) (1)

6 This ratio is defined as:

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

Table 13. Taffler Z-Model Analysis


According to the the analysis in

table 13, the Taffler model pre-

dicts bankruptcy for Debenhams.

However, in order to have a more

accurate analysis, a different

bankruptcy model has also been

used. Table 14 shows the accu-

racy of the forecasts of different

bankruptcy models across 3,505

medium-sized Russian enterpris-

es (Fedarova et al, 2012). The

Fulmer’s model appears to have

the highest overall efficiency in

predicting financial distress and

is the most accurate in identifying

healthy companies. Therefore,

if Debenhams is indeed healthy,

there is a higher probability it will

be identified by this model. The

Fulmer model predicts bankrupt-

cy when H < 0, which is the case

for Debenhams. Both Bankruptcy

model have predicted financial

distress for Debenhams.

There are many problems asso-

ciated with using the bankruptcy

models. Firstly, the ratios are

often calculated using historical

information, which in case of De-

benhams is represented by 2012

annual report as the latest data

have not been released yet. even

with the most recent data, there

is no theoretical explanation for

justifying the use of these mod-

els and, therefore, there is no

evidence that these models have

been specified correctly. Moreo-

ver, the model only predicts two

scenarios of bankrupt or no bank-

ruptcy, which is rather simplistic.

It is also important to point out

that these models predict bank-

ruptcy one year in advance. It has

been over ten months since the

release of the annual reports and

the company appears to be oper-

ating normally.

H=5.528(V1 )+0.212(V2 )+0.073(V3 )+1.27(V4 )-0.120(V5 )

+2.335(V6 )+0.575(V7 )+1.083(V8 )+0.894(V9 )-6.075

(2)

Table 15. Fulmer H-Model Analysis


eVA was developed in 1982 by

the corporate advisory firm of

Joel Stern and g. Bennett Stewart

III as a measure of the economic

profit, as opposed to the ac-

counting profit of an entity. The

difference between this method

of measurement and some “tra-

ditional methods” of measuring

profit is that EVA determines the

residual income of the company

“net of both the direct cost of debt

capital and the indirect cost of eq-

uity capital”. (grant, 2003)

3.8 Economic Value Added

There are two different methods

of defining the EVA namley the

accoutning and the finance ones.

This section concentrates on

evaluating Debenhams’ eVA by

using the acounting definition.

The accounting measure of eVA

is calculated as the Net operating

Profit After Tax less the weighted

average cost of capital.

Calculating NOPAT

The Net Operating Profit after tax

shows the ability of a company

in generating earnings when the

company in not geared. In deriv-

ing at NoPAT, certain adjustments

were made to the earnings before

interest and tax (eBIT) in order

to obtain a more accurate figure.

These adjustment were made as

shown in table 16.

EVA=NOPAT-£ Cost of Capital (3)

Table 16. NOPAT Calculations

7 Calculations are shown in the appendix


been conducted in deriving the

cost of equity and the weighted

average cost of capital required

certain assumptions to be

made. Furthermore, relying on

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.

Figure 74. EVA

8 Debenhams does not issue any bonds. So the Market value of the company’s loans had to be calculated by a specific relationship, which has been shown in the appendices. 9 Cost of Debt has been estimated by taking the weighted average of the company’s interest rates. The calculations have been shown in the appendices. 10 The return on the market has been calcu-lated 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 year’s calculation in order to get a positive value for this variable.

Cost of Capital

Since Debenhams does not is-

sue any preferred shares, the

weighted average cost of capital

is calculated by using the below

relationship:

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

τ = Corporate tax rate

The cost of equity of the company

has been calculated using the be-

low equation:

Rf = risk free rate (10 year UK govern-ment bond yields)

Β = systematic risk (Retrieved from Financial Times)

Rm = Return on the market10

CRP = UK’s average country risk pre-mium

ke=rf+β[(rm-rf )+CRP)] (5)

WACC=D⁄V .kd .(1-τ)+E⁄V .ke

(4)

EVA Calculations

The table and the bar chart below

show the trend of Debenhams’

EVA measure in the past five

years. As it can be seen, in the

years of the analysis, Debenhams

has been able to generate eco-

nomic profit.

Limitations in Deriving EVA

It is important to note that many

of the calculations, which had

2008

£m200

160

120

80

40

02009 2010 2011 2012

Table 17. EVA Calculations


FORE

CAST

ING

AND

VAL

UATI

ON

4.1 Introduction

The aim of this section is the val-

uation of the company’s equity.

Pinto et al (2010) defined the five

necessary steps in valuing a com-

pany’s stock. These steps are the

understanding the nature of the

business, forecasting company’s

earnings, selecting the appropri-

ate valuation model, converting

forecasts to a valuation and final-

ly applying the valuation conclu-

sions. The strategy of Debenhams

has already been extensively an-

alysed in the corporate strategy

section of the report. Therefore,

this section of the project aims

at taking the steps remaining in

valuing the company’s equity.


In this section of the report, De-

benhams’ future earnings have

been forecasted using various

methodologies. The purpose of

forecasting the future earnings is

so that the obtained results can

later be used in the valuation of

the company’s equity. The most

effective way by which forecasts

are conducted combines quanti-

tative forecasting methods, with

good judgement based on past

experiences. It is important to

avoid the total reliance on either

quantitative or judgmental meth-

ods (Reitsch, 1998). In general,

analysts’ reliance on data manip-

ulation techniques tends to be

greater, as the publicly available

information regarding the com-

pany’s overall performance may

be rather biased and therefore,

not a reliable benchmark for

judging the company’s future

profitability.

4.2 Forecasting Earnings

Data Collection and Trend analysis

Data collection

The earnings data for Debenhams

has been captured from DATA-

STReAM for the past ten years, as

shown in table 18. The author has

deliberately chosen this number

of observations for a number of

reasons. Firstly, choosing a long-

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

averages, exponential smoothing

and Box-Jenkins methodologies

are not good predictors of the

economic turning points and

their use is not appropriate for

long time-horizons. Secondly,

the author’s aim was to incorpo-

rate enough observations in the

analysis so that trends in the data

could have been identified.

Furthermore, some of the issues

encountered in the data selection

process were as follows:

• The author’s initial intent

was to use quarterly earnings

for conducting the analysis.

This was with the aim of hav-

ing a larger sample data and

performing a more accurate

analysis. However, quarterly

reports were not released by

Debenhams and the author

had limited access to interim

reports.

• Finally, due to the unavail-

ability of financial reports

prior to 2006, adjustments

for non-recurring expenses

have only been made for the

past five years.

Table 18. Debenhams’ Historical Earnings

2003 20082004 20092005 20102006 20112007 2012108.4 77.1-28.3 95.164.3 102.143.7 117.279 125.3

yearNet Profit


Trend Analysis

A quick glance at figure 75 indi-

cates a rapid drop in earnings in

2004, which was later followed

by an upward trend. However,

the visual interpretation of this

graph is of little value in correctly

identifying patterns. A method,

which is often used in examining

data patterns, is the autocorrela-

tion analysis. Time-series data is

frequently correlated with itself

when lagged one or more peri-

ods, hence, autocorrelation anal-

ysis is a useful tool for examining

this data (Reitsch, 1998).

The appropriate number of time

lags for conducting this analysis

is N/4, where N is the number of

observations. Hence, in this case,

three time lags were used for pro-

ducing a correlogram. This graph

reveals that the correlation coef-

ficients of the three time lags are

close to zero. Furthermore, the

t-statistics obtained by Minitab

for each correlation coefficient

suggests that none of the coeffi-

cients are significantly different

from zero. According to these

results, the autocorrelation anal-

Figure 75

Figure 76


ysis suggests that the data is ran-

dom. However, by looking at the

time-series analysis an upward

trend can clearly be observed.

It may be that the results from

correlogram are not statistically

significant due to the small sam-

ple size.

Another method of analysing the

data is by using Minitab’s Trend

Analysis function. This function

attempts to describe the trend

in the time-series by the means

of least squares method. This is a

method by which, a line that best

fits the observations is comput-

ed. The trend analysis function

has confirmed the existence of an

upward trend in the time-series.

This is consistent with the earlier

visual interpretations. However,

note that the MAPE is 41.94%,

which is a quite large percentage

error; hence, the trend identified

may not be statistically signifi-

cant.

Figure 77

Figure 78


In order to explain Minitab’s re-

sults in a more formal manner,

the findings of the trend analysis

function have been replicated by

conducting regression analysis.

The aim is to regress earnings

against time and find a line func-

tion in the form of:

Figure 78 shows the fitted line

plot, which has been obtained by

the regression analysis. The olS

plot is similar to that of the Trend

Analysis as both models use the

Ê=b0+bt (6)

Table 19. Regression Analysis

least squares measure in com-

puting the fitted line. As it can

be seen the equation of the best

fitted line is:

A snapshot of the regression

analysis from Minitab is shown

in table 19. By looking at the

student’s 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,

the R2 measure shows that only

Ê=27.99+9.163t (7)

38% of the changes in earnings

are explained by the variations in

time.

Thus, it can be concluded that

the results of the autocorrela-

tion analysis is consistent with

the lack of explanatory power of

the olS regression. Thus, even

though there appears to be an

upward trend in the data, the

statistical measures indicate that

the data is random and this trend

is not statistically significant.


Forecasting Methodologies

OLS Method

one method of forecasting the

earnings is by using the olS meth-

od. The regression analysis for

Debenhams’ earnings has already

been conducted in the previous

part. Hence, all is needed is to plug

the numbers 11, 12 and 13 in the

equation to obtain the forecasts

for the years 2013 to 2015. Fortu-

nately the Trend Analysis function

in Minitab is capable of making

this calculation. The results are

shown in the table 20.

Moving Averages

Moving averages is a forecasting

method by which a specified set

of earnings are averaged and

used in forecasting the future

period profits. The assumption

is that the past fluctuations in

the earnings are due to “random

departures” from a smooth earn-

ings curve. Hence, the averaging

of past observations smoothens

out the past fluctuations and aids

short term forecasting (Reitsch,

1998).

generally this model gives more

accurate results when it is used on

stationary data. However, when

the Augmented Dickey Fuller test

(ADF) was conducted in Stata, it

was shown that both the original

data and the first differences are

non-stationary. Nevertheless, this

model has been used in forecast-

ing Debenhams’ earnings, as it has

been suggested that it yields better

results than the simple average

forecasting models. (Reitsch, 1998)

Year201320142015

Year201320142015

Forecasted Earnings (£m)

128.79137.95147.11

Forecasted Earnings (£m)

103.36108.61111.31

Figure 79

Table 20. OLS Forecast Results

Table 21. MA Forecast Results

Figure 80


It is important to note that the

moving averages only take into

account the earnings in the past n

periods. Hence, choosing a small-

er number of periods means that

more weight has been put on the

most recent periods. In order to

put more emphasize on the re-

cent years only 5 earnings data

have been chosen as the number

of observations to be averaged.

As shown in figure 80, Minitab is

capable of performing Moving av-

erages forecasts. This graph only

shows the forecasted earnings of

2013. Due to the limitations of

Minitab, forecasts for the years

2014 had to be made by re-en-

tering the forecasted value for

2013 back into the time-series

and then re-running the function.

The same process had to be done

for 2015. The results have been

shown in table 21.

Random Walk Model

Many empirical researches have

shown that the earnings of a com-

pany exhibit a “random walk” or

“random walk with a drift” behav-

iour. According to this model, the

best benchmark for forecasting

the future earnings of a company

is its prior year’s earnings. A study

suggested that in comparison to

the simple random walk model of

forecasting earnings, the forecasts

conducted by professional analysts

are only 22% more accurate. (Pa-

lepu et al, 2010)

The Simple Random Walk model

is mathematically expressed as

follows:

The term ui is a noise term, which

has mean of zero and variance

of σ2. Therefore, E(Et+1) = Et and

var(Et) = tσ2. Thus, it can be said

that the mean of the random walk

process is expected to remain the

same, with its variance increas-

ing as t increases. If the earnings

follow a random walk with a drift,

then the relationship is as follows:

In this case, the d term is the drift

in the model. Therefore E(Et+1) = Et

+ td and var(Et) = tσ2.

The initial trend analysis indicated

that there is an upwards trend in

the time-series. Therefore, in con-

ducting the forecast using the ran-

dom walk model, it is important to

include the drift term to the model.

This drift term can be calculated by

taking the average of the first dif-

ferences of the time-series. Table

21 shows that the mean of the first

differences is 1.88. using this in-

formation the forecast of the years

2013 to 2015 can be made by for-

mula 9. Furthermore the standard

deviation can be measured by the

relationship sqrt(t)*σ.

Year201320142015

Forecasted Earnings (£m)127.18129.06130.94

E(t+1)=Et+ut (8)

E(t+1)=d+Et+ut (9)

Table 22. Descriptive Statistics

Table 23. Random Walk Forecast Results


Segmental Forecasting

Another method of forecasting

the future earnings of Debenhams

takes advantage of the compa-

ny’s segmental information. The

forecast of the future earnings

of a company is often aided by

analysing its segmental perfor-

mance, or as Arnold and Moizer

(1984) highlighted, by utilizing a

“break-down-and-build-up” ap-

proach. Furthermore, in a study

conducted by Kochanek (1974),

he observed that the stronger the

segmental reporting practices of

a company, the more accurate the

forecast of the future earnings of

that company.

Although Debenhams has re-

ported its sales for each seg-

ment, there are no records of the

company’s segmental earnings.

Hence, a specific model that

forecasts earnings based on the

regional sales and the consoli-

dated net profit has been used in

this section. This model, which

had been introduced by Roberts

(1980) is as follow as shown in

fromula 10.

The expected segmental growth

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

Statistics section of the report.

The geometric average of the

growth of the segments has been

used as the expected segmental

growth element of this model.

Table 24 shows the forecasted

earnings for 2013.

The segmental forecast has only

been made for the year 2013.

The author attempted to forecast

for the years 2014 and 2015 by

assuming that the sales growth,

level of sales and segmental sales

are fixed. However, these are very

unrealistic assumptions as they

would imply that the net profit

margin of the company increases

while it sales is never changed.

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

St is consolidated sales in period t.

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

Xt is consolidated earnings in period t.

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

cons

cons

seg

cons

seg

E(Xt+1│seg)=∑[1+E(GWTHj,t+1 )].Sj,t.( ) (10)cons segcons

consseg

t

j=1

Xt

St

Table 24. Segmental Forecast Results

Expected growth

Consolidates Sales, £m

Consolidated Earnings, £m

Segmental Sales, £m

Segmental Earn-ings Forecast , £m

3.24%-5.53%17.36%12.57%

2229.82229.82229.82229.8

125.3125.3125.3125.3

1860.3136.5142.790.3

107.927.259.415.71

130.29

Segments

uKIreland

DenmarkRest of the World

Consolidated Earnings


Table 25. Average of Forecast Results

Figure 81

Comparing Forecasting Results

In forecasting Debenhams’ earn-

ings different 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. quarter-

ly earnings) prevented the use

of more advanced forecasting-

ing methodologies such as the

Box-Jenkins technique. The use of

quarterly data would have been

more appropriate for forecasting

using smoothing and averaging

techniques, as these models

smoothen the seasonality effect

embedded in monthly and quar-

terly data.

Another issue concerns the ac-

tual nature of the data. The ADF

test conducted on Debenhams’

earnings showed both the origi-

nal data and the first differences

were non-stationary. The mov-

ing averages methodology gives

more accurate results when used

on stationary data. Also the use

of a long time-span of ten years

in conducting the analysis may

have prevented obtaining more

accurate forecast results, as the

economic cycles may have dis-

torted the data and resulted in a

shift in the time-series. Access to

five years of quarterly data would

have resolved this issue by pro-

viding a larger sample size within

a shorter time-span.

The data obtained for conducting

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

method Makridakis and Winkler

(1983) stated:

“In an extensive study of the

accuracy of forecasting meth-

ods, Makridakis et al., (1982,

1983) found that a simple av-

erage and a weighted average

of forecasts from six methods

outperformed virtually all or

perhaps even all of the individ-

ual methods, including the six

methods being combined as

well as the other sixteen indi-

vidual methods included in the

study”

Thus a single forecast was pro-

duced by averaging the results of

all methodologies.

OLS Moving Averages Random Walk Segmental Average128.79137.95147.11

103.36108.61111.31

127.18129.06130.94

130.29N/AN/A

122.41125.21129.79

(in £m)201320142015


A crucial assumption that needs

to be made in the valuation of a

company’s equity is that the in-

trinsic value of the equity differs

from its market price. The intrin-

sic value of the assets assumes

that the investment characteris-

tics of those assets are clearly un-

derstood. Therefore, the intrinsic

values that are often calculated

by investors reflect their views

on the stock’s actual worth (Pinto

et al, 2010).

Another assumption that has

been made in the valuation of

Debenhams’ equity is the go-

ing-concern assumption. earlier,

in the bankruptcy studies, it was

shown that two different mod-

els 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 company’s

performance has been more on

the positive side in the past few

years. As a result the author has

made the going-concern assump-

tion and has used the going-con-

cern valuation techniques.

4.3 Equity Valuation

Equity Valuation Using Appropriate Models

The going-concern valuation

models are divided in to two

groups as shown in figure 82.

The absolute valuation models

attempt to estimate the intrinsic

value of the equity. These esti-

mates can then be compared with

the actual stock prices to judge

whether the stock is fairly priced.

Absolute valuation models usu-

ally discount the expected future

cash flows of the company in

order to estimate the value of the

company’s stock. Models such as

the dividend discount model, free

cash flow model and the residual

income fall within this category

(Pinto et al, 2010).

The relative valuation models

on the other hand “estimate an

asset’s value relative to another

asset” (Pinto et al, 2010). These

methods of valuation, which are

also referred to as the market

based valuation models, often

use price multiples such as the

Pe, PCF, PS and PB. enterprise

value multiples also fall within

this category.

In this section some of the pop-

ular valuation techniques have

been introduced and where it

was appropriate, they had been

used in the valuation of the De-

benhams’ equity.

Relative Valuation Models

GOING-CONCERN VALUATION

Absolute Valuation Models

Figure 82. Going-Concern Valuation Techniques


Relative Valuation of Debenhams

Price multiples are popular ratios

for assessing the value of a com-

pany’s stock. The main reason un-

derlying their popularity is their

simplicity. using price multiples,

allows investors to determine

whether a company’s stock is

fairly valued. In studies conduct-

ed by Arnold and Moizer (1984),

Barker (1999) and a few other

scholars, it was shown that the

Pe ratio is one of the most impor-

tant methods of valuing a compa-

ny’s stock. Barker (1999) showed

that in general analysts prefer the

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

dividing the current stock price

by the last year’s earnings. Some

websites also report the forward

P/e ratio, which is calculated by

dividing the current stock price

by the forecasted earnings.

There are limitations to the Pe ra-

tio, as the earnings of a company

can be volatile or even at times

negative. Therefore, other mul-

tiples such as Price-to-cash flow

and price-to-sales have also been

calculated in this section11.

Debenhams’ price multiples have

been calculated as demonstarted

in table 27 along with the average

multiples of the industry. It is

evident that the price multiples

of Debenhams are lower than the

industry average. Furthermore, a

significantly Lower price to cash

flow implies that Debenhams is

better at generating cash flow

than the average industry.

The industry’s multiples can

be regarded as a standard for

calculating Debenhams current

fair value. This is done simply by

multiplying the industry price

multiples by Debenhams’ funda-

mentals.

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.

Table 27. Debenhams and Industry Price Multiples

Table 26. The Derivation of Per Share Fundamentals

Price Multiplies Debenhams Industry AverageP/eP/S

P/CF

11.030.626.87

15.271.65

23.15

Net profitSales

Cash FlowShares outstanding

earnings per share (ePS)Sales per share

Cash flow per share12 Current price

£125.30m£2,229.8m£201.50m1281.3m

9.80p174p

15.73p108.10p


As it can be seen the fair value

of Debenhams’ equity has been

estimated to be much higher than

the current stock price. Accord-

ing to this model, the stock price

is undervalued. Finally, the share

price of Debenhams in 2014 can

also be calculated by multiplying

the industry average of the P/e

ratio by the earnings forecasted

in the previous section. It is im-

portant to note that in doing so

the industry P/e ratio is assumed

to remain stable. In other words,

assume:

( P/E )2014 = ( P/E )2013 (11)

P2014=( P/E )2013 ×Ê2013 =15.27 ×9.6p13 =146.59p (12)

Dividend Discount Model

The dividend discount model is

one of the simplest discounting

cash flow methods for measuring

the intrinsic value of a company’s

stock. A survey conducted by

Block (1999) indicated that 42%

of the respondents considered

the dividend discount model very

important for valuing the equity

of the individual companies. By

referring back to the ratio anal-

ysis section of the report, it can

be observed that Debenhams had

volatile dividend yields in the

years of the analysis. The dividend

discount model is generally not

considered a suitable valuation

technique for companies that pay

unstable dividends. However, in

this case the author believes that

this model is suitable for valuing

Debenhams’ stock. Debenhams’

dividend payments and the level

of company’s retained earnings

are shown in table 29. It is be-

lieved that following the financial

turmoil of 2008, Debenhams de-

creased and eventually stopped

paying dividends due to its high

levels of negative retained earn-

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

Table 28. Valuation By Comparables

Multiplies Industry Fundamentals Debenhams Fair valueP/eP/S

P/CF

15.271.65

23.15

ePSSales per share

Cash flow

9.8p174p

15.73p

149.65p287.1p364.15

266.97Average

Table 29. Trend in Debenhams’ dividends and Retained Earnings

2008 2009 2010 2011 20125.16

-574.60.25

-546.60

-176.21

-15.13

-9.9Dividend per share (in pence)

Retained earnings (£m)

Therefore:


ing, in an attempt to recover it.

The considerable improvement

in the company’s retained earn-

ings appears to be correlated

with the increased levels of div-

idend payments. According to

the corporate strategy section of

the report the uK economy has

shown signs of recovery and al-

though the retail industry growth

has been slow, the government’s

expansionary policies are expect-

ed to favour this industry. There-

fore, the author believes that by

2013 Debenhams will be able to

recover its retained earnings and

as a result, Debenhams’ dividend

payments are expected to grow

to its previous level in 2008. In

other words:

However, after 2013 the company

is expected to grow at a sustaina-

ble rate of 2.4%. This sustainable

growth rate has been derived

based on PwC’s projections of

the uK gDP growth in the years

2015 to 2019. Hence, for valuing

Debenhams’ stock the two-stage

dividend discount model has

been used. The cost of equity has

already been calculated for meas-

uring the eVA and is estimated to

be 6.47%. The two-stage model is

as follows:

E(D2013 )=D2008 (13)

gs= -1= -1=72%

(14)

E(D2013 ) 5.16D2012 3

V0=∑ + (15)t=1

n D0(1+gs )t

(1+r)t

D0 (1+gs )t (1+gL )

(1+r)n(r-gL )

V2012= + = 119.4p 5.16

1.06745.28

1.0674 x 0.0434

Before making any conclusions,

it is important to note that this

estimated intrinsic value is based

on fundamentals retrieved from

the 2012 financial reports. There-

fore, unlike the relative valuation

models, the intrinsic value needs

to be compared with the market

price at the date when the finan-

cial reports were first published.

The stock price of Debenhams on

the 3rd of September 2012 was

97.95 pence, which implies that

Debenhams’ stock at that time

was undervalued. Furthermore,

comparing this result with the

current stock price of 108.10p

still shows that Debenhams’

stock is undervalued. Therefore

the dividend discount valuation

results reaffirm the findings of

the relative valuation techniques.


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-

main unchanged in the next two

years. Thus, the foreccasted ePS

for 2013 and 2014 are a shown

in table 31. For measuring the

book value of equity for the years

2013 and 2014, the clear surplus

relationship had been used. This

relationship is as follows:

Bt=B(t-1)+Et-Dt (17)

V0=B0 +∑ = t=1

RIt

(1+r)t B0 +∑ (16)t=1

Et-rBt-1

(1+r)t

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

cost of raising capital is generat-

ing economic profit and creating

value. The economic value added

that was calculated for Deben-

hams in the financial analysis sec-

tion showed that in the past five

years Debenhams has been able

to generate and sustain a consist-

ent flow of economic profit.

“Thus, all else equal, higher

(lower) residual income should

be associated with higher (low-

er) valuations” (Pinto, 2010).

The residual income valuation

model measures the value of the

company’s equity, by adding its

current book value to the total

present value of expected future

residual incomes. In mathemati-

cal terms, this can be defined as

follows:

For valuing Debenhams’ equity,

the multi-stage residual income

model was chosen. As it was

shown earlier in the ratio anal-

ysis section, Debenhams had

high ROE of about 60% in 2008,

which over time faded to only

20%. Based on the forecasts, it is

believed that the Roe will further

decrease. Having already calculat-

ed the forecasted dividends and

earnings for 2013 and 2014, the

book value of Debenhams’ equity

can be measured for these years

2013 2014earnings per share

Book value per shareReturn on equity

9.56p55.99p17.07%

9.77p60.18p16.23%

2013 2014Forecasted Net Profit

Shares outstandingePS

£122.41m1,281.3m

9.56p

£125.211,281.3m

9.77p

Table 30. The Forecasted Return On Equity

Table 31. The Forecasted EPS


RIt=Et-rB(t-1) (19)

(20)

V2014= B2014 + B2014 = 60.48 + 60.48 = 181.87p (18) ROE - r

r - g0.1544 - 0.6740.0674 - 0.024

2013 2014Residual Income 6.08 6.00

Table 32. Debenhams Residual Income

Once these figures have been es-

timated, Debenhams’ forecasted

Return on equity is derived as

shown in table 30. It is expected

that by 2014 the Roe decrease to

about 16%, which is close to the

retail industry average of 15.44%.

Therefore, after this year it can

be assumed that the Roe will re-

main stable, at a rate equivalent

to that of the uK’s retail industry.

average. The value of Debenhams’

stock in 2014 can be calculated by

relationship below:

However, this is the value of De-

benhams’ stock in 2014. The re-

sidual income for 2013 and 2014

will be calculated by the relation-

ship 19.

Finally, the value of Debenhams’

equity in 2012 can be calculated

by relationship 20.

Both the DDM and the residual

income valuation techniques

should theoretically yield the

same results. However, even

though the same growth rate

and cost of equity were used in

this section and the book values

were calculated using the divi-

dends that had been forecasted

in DDM, different results were

obtained. So far all the models

which have been used in valuing

Debenhams’ equity suggested

that the Debenhams’ share prices

are under-valued. In order to an-

alyse how sensitive the elements

in these models are to variations,

sensitivity analysis has been con-

ducted in the next section.

V0=B0 +∑ + = 51.59 + + + = 169.56p t=1

T RIt

(1+r)t0.08

1.06746

(1.0674)2181.87 - 60.18

(1.0674)2

PT - BT

(1+r)T


Sensitivity Analysis

As it was shown earlier, different

results were obtained by the re-

sidual income and the dividend

discount models. However, it is

important to note that in deriv-

ing many of the elements used in

these models assumptions had

to be made. Therefore, in this

section of the report sensitivity

analysis will be performed to

show the extent to which the re-

sults would be different, if these

elements are altered.

Residual Income Model

As it can be seen, the highest

elasticities are for the sustaina-

ble growth rate and the market

return. However, variation in

these parameters did not result

into a change in the investment

decision. Even with +/-20% var-

iations in the parameters, Deben-

hams is undervalued.

-20% Original +20%Variations in the Parameters

Parametersearnings per share in 2013earnings per share in 2014

expected Dividends in 2013expected dividends in 2014

Risk free rateMarket return

BetaCountry risk premium

Sustainable growth rateSustainable return on equity

7.657.824.134.22

1.52%3.49%1.18

0.66%1.92%

12.35%

9.569.775.165.28

1.90%4.36%1.47

0.83%2.40%

15.44%

11.4711.726.196.34

2.28%5.23%1.76

1.00%2.88%

18.53%

-20% Original +20%Equity Value Parameters

earnings per share in 2013earnings per share in 2014





164.39164.4

171.32171.42162.72242.00219.27179.88158.94131.76

169.56169.56169.56169.56169.56169.56169.56169.56169.56169.56

174.73174.72167.8167.7

177.00130.10138.01160.34182.82207.37

ElasticitiesParameters

earnings per share in 2013earnings per share in 2014





0.150.15-0.05-0.050.22-1.16-0.93-0.270.391.11

Table 33. Variations in RI Model’s Parameters

Table 34. Valuation Results From Varying RI Model’s Parameters

Table 35. The Elasticity of Parameters in RI Model


-20% Original +20%Equity ValueParameters

Short term growthRisk free rate

Market returnBeta

Country risk premiumSustainable growth rate

109.84114.69169.34153.57126.47107.54

119.40119.40119.40119.40119.40119.40

128.96124.5192.2497.69

113.06134.21

-20% Original +20%Variations in the Parameters

ParametersShort term growth



Sustainable growth rate

57.60%1.52%3.49%1.18

0.66%1.92%

72%1.90%4.36%1.47

0.83%2.40%

86.40%2.28%5.23%1.7641.00%2.88%

ElasticitiesParameters

Short term growthRisk free rate

Market returnBeta

Country risk premiumSustainable growth rate

0.400.21-1.14-0.91-0.270.62

Dividend Discount Model

From table 37 it is evident that

an increase in the market return

or the Beta by 20% would cause

the intrinsic value of Debenhams

to fall below Debenhams’ share

price on the 3rd of September

2013. This would lead to a change

in the investment recommenda-

tion.

Table 36. Variations in DDM’s Parameter

Table 37. Valuation Results From Varying DDM’s Parameters

Table 38. The Elasticity of Parameters in DDM Model


Concluding Remarks

In this report the strategy and

financial performance of De-

benhams plc was thoroughly

analysed and the value of the

company’s stock was estimated.

The analysis of Debenhams’ strat-

egy showed that Debenhams is

heavily investing in e-commerce,

increasing the number of its uK

stores and opening franchises in

emerging markets. Considering

the rapid growth in e-commerce

sales in recent years, the com-

pany’s increased investments

in multi-channel is seen as a

viable strategy. Furthermore,

the growth in the sales of Deben-

hams’ rest of the world segment

is an indication that Debenhams

may benefit from investing in

new markets and expanding its

brand internationally. on the

other hand there have been some

debates as to whether expansion

within the uK market would lead

to economies of scale. Particular-

ly, the decreased growth in the

street sales of uK retailers in the

prior years may be a signal that

opening new stores would lead

to increased costs, which may

not get compensated by signif-

icantly higher sales. Neverthe-

less, the bullish forecasts of the

economy’s growth along with

the increased momentum of the

retail industry and the improved

consumer confidence may all be

indications that such a strategy

may indeed benefit Debenhams

in the long-run.

The financial analysis of Deben-

hams indicated that this com-

pany has been able to increase

its net profits in the years of the

analysis, and the majority of the

company’s ratios showed opti-

mistic trends. Some highlights

are the substantial decrease in

the level of Debenhams’ gearing

and financing costs, which led to

the upward trend of the firm’s net

profit margin. However, the oper-

ating profit margin continues to

decline, which is an indication of

poor management of operating

costs. Furthermore, the recovery

of the company’s retained earn-

ings from about -£550m to -£9m

in the past five years resulted in

initiation of dividend payments

in 2010 and the rapid growth of

dividend pay-outs in 2011 and

2012. on the lower end of the

scale, the company’s low liquidi-

ty and bearish bankruptcy scores

all indicate that Debenhams may

experience financial distress in

the case of a market downturn.

Furthermore, the company’s

assets include high amounts of

intangibles, which pose a serious

threat should they require writ-

ing down.


The forecast of Debenhams’ earn-

ings showed that the company’s

net profit is expected to drop in

2013; however, this forecast has

been based on statistical mod-

els that only take historical data

into consideration. Hence, total

reliance on this data is somewhat

naive. For instance, the increased

sales of the uK retailers in the

summer of 2013 may break this

forecast and lead to the growth of

Debenhams’ earnings this year.

The valuation of Debenhams’

stock using both the relative and

intrinsic valuation techniques

showed that Debenhams’ stock is

undervalued. As discussed earlier

the intrinsic valuation techniques

gave different results, which is

most likely due to the assump-

tions that were made on the com-

pany’s Roe in using the residual

income model. Therefore, in de-

riving the target market price of

Debenhams in 2013 the average

of the two valuation techniques

was used (see table 39).

A positive economic outlook, un-

dervalued share prices, historical

improvements in the company’s

ratios and fundamentals and low

level of short selling by the mar-

ket participants all suggest that

Debenhams’ shares should be

purchased.

Dividend Discount Model Residual Income Model Average119.40 169.56 144.48

Table 39. Calculation of the Target Price

Figure 83. Debenhams’ Short-Selling Activity


Ashley Payne - Debenhams talks Innovation in Multi-Channel at the EcommerceUK Event. (2012, November 5). Retrieved July 8, 2013, from Youtube: http://www.youtube.com/watch?v=SF99PNmJ98c

Abeysinghe, T., Balasooriya, U., & Tsui, A. (2000). Small-Sample Forecasting: Regres-sion or ARIMA Models? 1-22.

Altman, E. I. (1968). Financial Ratios, Discriminant Analysis and the Prediction of Cor-porate Bankruptcy. Fournal of Finance, 589-609.

Altman, E. I. (2000). Predicting Financial Distress of Companies: Revisiting the Z score and Zeta Models. Journal of Finance, 15-22.

Aruba Networks. (2012). Technology Advances in Retail: Improving Margins using Wireless Networks. Sunnyvale: Aruba White Paper.

Baldwin, B. A. (1984). Segment Earnings Disclosure and the Ability of Security Ana-lysts to Forecast Earnings Per Share. The Accounting Review, 376-389.

Bank of England. (2013, January 02). 10 Year UK Government Yields. Retrieved August 10, 2013, from Bank of England: http://www.bankofengland.co.uk/

Barker, R. G. (1998). The Market for Information - Evidence From Finance Directors, Analysts and Fund Managers. Accounting and Business Research, 29, 3-20.

Barker, R. G. (1999). The Role of Dividends in Valuation Models Used by Analysts and Fund Managers. The European Accounting Review, 192-218.

Barker, R. G. (2000). FRS3 and Analysts’ Use of Earnings. Accounting and Business Research, 30, 95-109.

Barley, R. (2013, February 25). The U.K.’s Rising Political Risk Premium. Retrieved July 13, 2013, from The Wall Street Journal: http://online.wsj.com/article/SB10001424127887323699704578326122073885996.html

BBC. (2011, July 28). Vince Cable Vows to Simplify Retail Rules. Retrieved August 07, 2013, from BBC: http://www.bbc.co.uk/news/business-14320470

Beaver, W. H. (1966). Financial Ratios as Predictors of Failure. Empirical Research in Accounting: Selected Studies, 71-111.

Best-CD-Price Shopping. (2013). About Debenhams. Retrieved August 2, 2013, from Best-cd-price.

Brealey, R. A., Myers, S. C., & Allen, F. (2008). Principles of Corporate Finance (9th ed.). New York: McGraw Hill.

Burt, S., Sparks, L., & Teller, C. (2010). Retailing in the United Kingdom - a synopsis. Scotland: Institute for Retail Studies, University of Stirling.

CFA Institute. (2012). Financial Reporting and Analysis. Pearson.

China Risk Management. (n.d.). Political Risk. Retrieved August 3, 2013, from China Risk Management: http://chinariskmanagement.com/Political.html

A

B

C

Bibliography


Cornett, M. M., Adair, T. A., & Nofsinger, J. (2012). Finance: Applications and Theory. New York: McGraw-Hill/Irwin.

Debenhams. (2011, September). Strategy Review. Retrieved July 15, 2013, from De-benhams: http://ar11.debenhamsplc.com/strategy-review/

Debenhams. (n.d.). History of Debenhams. Retrieved July 3, 2013, from Debenhams’ Heritage: http://www.debenhamsheritage.com/index.php/article?id=81

Debenhams plc. (2008-2012). Annual Reports and Accounts.

Fedorova, E. A., Gilenko, E. V., & Dovzhenko, S. E. (2012). Models for Bankruptcy Fore-casting: Case Study of Russian Enterprises. Financial Problems, 159-164.

Financial Times. (2013). Equities. Retrieved from Financial Times: http://markets.ft.com/

Glass Door. (2013). An Inside Look At Jobs and Companies! Retrieved August 2, 2013, from Glass Door: http://www.glassdoor.co.uk/index.htm

Gompertz, S. (2013, August 6). UK Retail Sales Boosted By July Heatwave. Retrieved August 18, 2013, from BBC: http://www.bbc.co.uk/news/business-23583825

Grant, J. L. (2003). Foundations of Economic Value Added. New Jersey: John Wiley & Sons, Inc.

Hussain, S. (1997). The Impact of Segment Definition on the Accuracy of Analysts’ Earnings Forecasts. Accounting and Business Research, 27(2), 145-156.

Hussain, S., & Kou, W. (2007). Predictive Gains to Segmental Disclosure Matrices, Geographic Infromation and Industry Sector Comparability. 183-195.

Internet Retailing. (2013, April 18). Debenhams reports 46% first-half boost to ecom-merce sales. Retrieved July 3, 2013, from Internet Retailing: http://internetre-tailing.net/2013/04/debenhams-reports-46-first-half-boost-to-ecommerce-sales/

Irwin, D. (1998). Make Your Business Grow: Take a Strategic Approach. London: Inter-national Thomson Business Press.

Kato, A. (2011). Productivity, Returns to Scale and Product Differentiation in the Retail Trade Industry: An Empirical Analysis Using Japnese Firm-Level Data. Berlin: Springer Science+Business Media.

Kay, J. (1993). Foundations of Corporate Success. New York: Oxford University Press.

Kochanek, R. F. (1974). Segmental Financial Disclosure by Diversified Firms and Securi-ty Prices. The Accounting Review, 245-258.

Koenig, P. (1997, December 14). Debenhams gets a brand new image. Retrieved June 15, 2013, from The Independent: http://www.independent.co.uk/news/busi-ness/debenhams-gets-a-brand-new-image-1288633.html

London Economics. (1997). Competition in Retailing. London: Crown.

D

F

G

H

I

K

L


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: http://www.thisismoney.co.uk/money/news/arti-cle-2290685/Debenhams-joins-big-squeeze-retailers-force-cuts-payment-de-lays-suppliers.html

MacDonald, G. (2011, September 5). Debenhams Claims Retail World-First With Smartphone Innovation. Retrieved July 15, 2013, from Retail Week: http://www.retail-week.com/debenhams-claims-retail-world-first-with-smart-phone-innovation/5028755.article

Marks & Spencer plc. (2008-2012). Annual Reports and Financial Statements.

Marsh. (2013). Political Risk 2013. Retrieved August 16, 2013, from Marh: http://usa.marsh.com

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: http://uk.reuters.com/arti-cle/2013/07/31/uk-britain-consumers-gfk-idUKBRE96T0X720130731

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: http://www.theguardian.com/news/dat-ablog/2009/oct/21/uk-population-data-ons#

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 Technol-ogies in Large Organisations. Retrieved August 04, 2013, from Slideshare: http://www.slideshare.net/practicology/multichannel-innovationdebenhams

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: http://www.bbc.co.uk/news/business-23692102

PwC. (2013). Global Economy Watch . Retrieved July 19, 2013, from PwC: http://www.pwc.co.uk/economic-services/global-economy-watch/gew-projections.jhtml

PwC. (July 2013). UK Economic Outlook. PwC.

Reitsch, A. G. (1998). Business Forecasting (6th ed.). New Jersey: Prentice Hall.

M

NO

P

R


Retail Owners Institute. (2013, July 23rd). Key Financial Ratios for Retailers. Retrieved July 23rd, 2013, from The Retail Owners Institute: http://www.retailowner.com/

Retail Research. (2013, january 18). The Retail Forecast for 2013-2014. Retrieved July 16, 2013, from Centre for Retail Research: http://www.retailresearch.org/retailforecast.php

Reuters Annual Report. (2013). Detailed Stock Report. New York: Thomso Reuters.

Rhodes, C. (2013). The Retail Industry. London: House of Commons Library.

Sadun, R. (2008). Does Planning Regulation Protect Independent Retailers? Cen-trePiece, 4.

Saunders, N. (2013). What Technologies Are On The Horizon For The Retail Industry? Retrieved August 3, 2013, from The Guardian: http://www.theguardian.com/media-network-partner-zone-ebay/technology-retail-industry

Shakespeare, S., & Baker, G. (2013, March 6). Debenhams’ Profit Scare. Retrieved July 22, 2013, from YouGov: http://yougov.co.uk/news/2013/03/06/deben-hams-profit-scare/

Shields, A. (2010, April 17). Debenhams Defends Own-Bought Strategy. Retrieved August 13, 2013, from Drapers: http://www.drapersonline.com/news/multi-ples-news/debenhams-defends-own-bought-strategy/5012184.article#

Smart Investor. (2012, October 15). Smart Investor: Have Debenhams Shares Got Fur-ther to Go? Retrieved July 15, 26, from Citywire Money: http://citywire.co.uk/money/smart-investor-have-debenhams-shares-got-further-to-go/a625489

Stock, J., & Watson, M. (2008). Introduction to Econometrics, Brief Edition. Boston: Pearson Education.

Ted Baker plc. (2008-2012). Reports and Accounts.

The Courtauld Gallery. (n.d.). Debenhams & Freebody. Retrieved July 1, 2013, from The Courtauld Gallery: http://www.courtauldprints.com/image/176113/clark-&-russell-debenham-and-freebody

The Economist. (2013, June 25). World GDP. Retrieved August 08, 2013, from The Economist: http://www.economist.com/blogs/graphicdetail/2013/06/focus-7

Trading Economics. (2013, June 21). United Kingdom Consumer Confidence. Retrieved July 15, 2013, from Trading Economics: http://www.tradingeconomics.com/united-kingdom/consumer-confidence

UK Government. (2013, March 20). Budget 2013: An Overview. Retrieved August 09, 2013, from UK Government: https://www.gov.uk/government/news/budget-2013-an-overview

Winkler, R. L., & Makridakis, S. (1983). The Combination of Forecasts. Journal of the Royal Statistical Society, 150-157.

Winterbotham, G. J. (2008). Predicting Future Corporate Earnings and Geographic Segment Disclosures. Norman: ProQuest Information and Learning Company.

S

T

U

W


Financial Ratios

Profitability Ratios


Liquidity Ratios

Return on Capital Employed =Average(Ordinaty Share Capital+Preference Share+Reserves+Debentures)

Profit Before Interest and Tax

Quick Ratio (Acid Test) =Current Liabilities

Cash+Marketable Securities+Receivables

Cash Conversion Cycle = Inventory Turnover Period + Trade Receivables Collection Period

- Trade Payables Settlement Period

Gross Profit Margin =Revenue

Gross Profit

Operating Profit Margin =Revenue

Operating Profit

Net Profit Margin =Revenue

Net Profit

Return On Equity =Total Shareholder’s Equity

Net Income

Inventory Turnover =Average Inventory

Cost of Sales

Current Ratio =Current Liabilities

Current Assets

Asset Turnover =Total Assets

Sales

Average Inventory Turnover Period = x 365Cost of Sales

Average Inventory Held

Trade Receivables Collection Period = x 365Credit Sales Revenue

Average Trade Receivables

Trade Payables Settlement Period = x 365Credit Purchases

Average Trade Payables

Appendices


Capital Structure and Debt Management

Market Value Ratios

Retail Specific Ratios

Three-Step Du-Pont Analysis

or

Interest Coverage Ratio =Interest

Cash From Operating Activities+Interest Received+Dividends Received

Gearing Ratio =Share Capital+Reserves+Long Term Debt

Long Term Debts

ROE = + +Revenue Total Assets Total Shareholder’s Equity

Net Income Revenue Total Assets

Dividend Yield =Market Value per Share

Dividend per Share ⁄ (1-Corporate Tax rate)

Basic Earnings per Share =Weighted average number of shares outstanding

Net Profit after Tax and Preferred Dividends

Interest Coverage Ratio =Interest Payable

Profit before Interest and Tax

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

Cash Ratio =Current Liabilities

Cash + Marketable Securitieis

Cash Coverage Ratio =Interest + Tax

Cash From Operating Activities

Price to Earnings Ratio =Earnings per Share

Market Value per Share

Gross Margin Return On Inventory =Average Inventory Cost

Gross Profit

Sales per Square Foot =Total Floor Space in Square Foot

Revenue

Cash Generated From Operations to Maturing Obligations =Current Liabilties

Cash generated From Operations

x 100


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+β[(rm-rf )+CRP]

Where:

• Risk Free rate = 10 years UK Government Bond Yields retrieved from Bank of England’s Website

• β = 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)

• Annual Return on the Market = Holding Period Return =

• Country Risk Premium = Retrieved from BBCRt-1

Rt - Rt-1

Market Value of Equity = Weighter average Number of Shares Outstanding × Current Share price

Table 40. The Calculation of Cost of Equity

Table 41. The Calculation of Makret Value of Equity

Table 42. The Calculation of the Market Value of Debt

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


Economic Value Added Calculations

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

deprecation. If appropriate, some of these policies will further be compared with Debenhams’s peer group,

which include the retail companies of Ted Baker, N Brown group and Marks & Spencer.

Debenhams’s 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 state-

ments. The financial statements have further been prepared in accordance with the Company Act 2006.

This Act is applicable to the companies which have adopted the standards required for reporting in the eu.

Debenhams’s peers all operate on the going concern basis. They have further all adopted the IFRS and the

company’s act 2006, which means fewer adjustments were required for conducting the analysis.

Weighted Average Cost of Capital

Table 43. The Calculation of WACC

Table 44. The Calculation of Tax Subsidy on Deductible Expenses


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 company’s 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). Rev-

enue 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

that the company has a return policy, which allows its customers to return the items they have purchased.

Debenhams (2012) further claims that the total amount of returns is estimated based on the “accumulated

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.

Department store goods and the “commission on concession and con-signment” sales are recognized as revenue, the instance the goods are sold to the customers, regardless of the method of payment.

Sales made through the internet are recognized as Revenue the in-stance the goods have been dispatched to the customers.

Sales which have been made by gift cards or gift Vouchers are rec-ognised as revenue, when they have been redeemed.

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

Store Sales

Internet Sales

Gift Card Sales

Sales to franchisees

Method of Sale Revenue Recognition


Expense Recognition

Depreciation

Tangible assets with the exclusion of land are depreciated with the aim of allocating the asset’s cost over

its useful economic life. Debenhams depreciates its property, plant and equipment (PPE) at specific rates as

shown in the table below. The depreciation is written off the cost of PPe, less residual value, on a straight

line basis from the point that they were first brought into use.

Freehold landFreehold buildings

long leasehold land and buildings15

Short leasehold land and buildingsRetail fixtures and fittings

Office equipmentComputer equipment

Vehicles

Not depreciated1%

1% or life of lease if shorterlife 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 Debenhams’s 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,

this could be a red flag as the company may be recognizing less depreciation costs and hence report higher

profits.

Cost of Goods Sold

In estimating the cost of goods sold (CogS), Debenhams measures inventory at lower of cost or net real-

izable value utilizing the retail inventory method. The retail method takes into consideration stock loss or

items which were sold below cost. Furthermore, concession inventories are not included in the inventory

reported by the group.

All Debenhams’s 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-in-

first-out basis. In order to make this data comparable to the other three companies, making an adjustment

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

adjustments section.

15 Included in both long and short leasehold land and buildings is the landlord’s fixtures and fittings


The Amortization of Goodwill

Goodwill by definition is the purchasing price of the company’s subsidiaries less the fair value of the ac-

quired subsidiary’s 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”.

This allocation was mainly the result of the acquisition of Debenhams stores by Debenhams plc in December

2003.

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.

Software development costs under both the uS gAAP and IFRS are treated as expenses unless the product’s

“technological feasibility has been established”. In this case the expense is capitalised as it is expected to

bring future economic benefits.

Debenhams intangible assets include “assets in the course of construction”, which are primarily web devel-

opment projects, which include costs needed to bring the assets in to use.

The rates at which Debenhams’s intangible assets16 are amortised are as shown below:

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.

16 excluding goodwill

Table 47.

Acquired licenses and trademarksInternally generated software

Purchased Software

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

Table 48.


Finance Lease Expenses

Finance leases transfer all the risks and rewards of the ownership to the lessee, which in this case is the De-

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

both 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.

The lease payments have been “apportioned between the finance charges and reduction of the lease obliga-

tion” 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

is aimed at Hong Kong and the uK. The contributions to these schemes are recognized as expenses in the

income statement when they “fall due”. The contribution scheme for instance can be identified as employee

benefit expense on the income statement.

Debenhams PlC recognizes actuarial gains and losses in full in the period in which they occur in the state-

ment of comprehensive income.

Past service costs incurred by Debenhams are immediately recognised in the income statement with the

exception of the situation in which the changes in the pension plans are conditional on the “employees

remaining in service for a specific period of time (the vesting period)”. In this case the services cost is amor-

tised over the vesting period.


Critical Accounting Estimates

Many estimates are made by Debenhams and its peers regarding the future. For instance, as earlier de-

scribed, 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. Further-

more, by analysing historical and expected future events the company analyses the judgements it makes

frequently. Debenhams has thus outlined the estimates and judgements, which may have material impact

on the future financial statements of the company. Some of these estimates and the judgements are made in

the following cases.

• 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.

• The level of vesting for expensing the fair value of share – based payments needs to be estimated and

requires annual reviews by the management.

• Actuaries in measuring the defined benefit obligations employ many assumptions into their calcula-

tions such as return on plan assets, discount rates, mortality rates, inflation, future salary and pension

costs. These estimates may differ to the actual outcomes.

• Debenhams estimates the useful economic life of PPE at the end of each financial year and assesses for

impairment when necessary.

17 As with the case of estimated number of annual returns

debenhams analyst report

Documents