The Ability of Debenhams of Generating Profits - Coursework Example

FINANCIAL PERFORMANCE AND INVESTMENT ADVICES OF DEBENHAMS PLC 0. INTRODUCTION Debenhams owning UK heritage was started back in 1778 with a drapersstore in London. Today, the company deals in multi-brands with having presence in 28 countries with 240 stores as well as online operations in 70 countries. In the UK market, company enjoys the fourth largest market share occupant in women and men apparel industry (Debenhams. 2014) while UK retail industry is facing fierce competition (i2i Events Group. n.d.). Although, strong position of the company is depicted by its heritage and market share but still the share price of the company is continuously fluctuating after 2008 economic recession (Hargreaves Lansdown. n.d). Considering the Share price fluctuations of the company, Debenhams is chosen to evaluate its financial performance with the aim to advice investment decision for sustaining in competitive market as share price indicates critical aspects of financial performance of any player within a particular industry. The paper includes financial performance analysis via employing financial ratios and corporate governance issues of the company. 2.0 FINANCIAL PERFORMANCE OF DEBENHAMS 2.1. REVENUE AND NET PROFIT OF DEBENHAMS Below presented is a snapshot to develop the general idea of the company’s performance via analysing the revenue and actual net profit trend. From the graph it can be visualized that company’ revenue has limited growth while net income is declining. Indicated in Annual Report (2014) increase in operating expenses are squeezing operating profit margins; thus, ending in lower net income year-by-year. Major impact is from high distribution and administrative costs which is due to limited ability of the company in optimizing continuously developing global supply chain Annual Report. (2014). 2.2 PROFITABILITY RATIOS 2.2.1 GROSS PROFIT MARGIN Gross profit margin is developed to evaluate the ability of Debenhams of generating profits after meeting cost of goods sold over 5-year period. Analysis revealed worsening position across years of analysis. Annual report 2014 noted reason as increase in cost of sales and sluggish growth in the revenue. The situation is due to controlled purchasing behaviour of consumer with less disposable income almost faced by whole UK retail industry because of stagnant economic growth (Davey, 2013). 2.2.2 NET PROFIT MARGIN Net profit margin is considered as the most important performance indicator of a company. It is used to compare the final earnings after taxes of the firm as a percentage of total sales. Mapping of the calculated ratio provides evidence of a sharp decline in last two years due to shaky operating performance. The U turn in the net profit margin is the result of almost consistent revenue but consistency in rising cost. Evident from the annual report 2014 the impact of distribution cost is notable which is swelled from high rate of 20 to 27% across five years moreover unutilized capacity of stores and promotional campaigns are hurting the overall profit margins of the company (Fashion United. 2014a). Underperformance of 10 percent of the business units in UK is the main cause of ending up with lower pre-tax income which in turn affected net income ((Fashion United. 2014b). 2.2.3 RETURN ON EQUITY The ratio is employed to assess the final returns that business is deriving for the investors. The declining numerator (net income) of the ratio is already noted above. Secondly, Annual Reports notes that the phase of debt reduction due to which equity per share is increasing on the whole both of the factors are moving the ratio towards downtrends (Business Teacher. 2014). However, company is able to generate surplus cash and distribute it among the shareholders using share buyback scheme till 2013. Hence, it is difficult to conclude that company is losing its viability for the financial markets (Annual Report. 2013). 2.3. INVESTMENT RATIOS 2.3.1 EARNINGS PER SHARE The ratio indicates allocation of total earnings to each outstanding share. Declining trend of earnings per share is again implying the impact of reduced net income year-by-year on the measure. Hence, business is facing challenges in consistently improving EPS as a result of failure in controlling costs of operations (Annual Report. 2013). 2.3.2 PE Price to earnings ratio is used for valuation and forecast of price and earnings per share with respect to PE multiple. It is the evidence about the readiness of the investors to pay higher for each unit of earning generated by the firm. Higher PE value obviously indicates higher potential of future earnings. Fluctuation in the PE of Debenhams ratio is mainly due to the decline in the earnings. The U shape initiated due to buyback schemes (LSE. 2014c) as such programs is often used for the purpose (Clement, 2014). Otherwise, the company is facing problems because of trading turmoil in UK retail market. Lowering net income led to lower EPS 2014 as share buyback scheme is discontinued for the year (Annual Report. 2014). Also fall in PE can be attributed to the investors’ reducing optimism about the earnings of the company. The price rose after new chief joined the company in 2011 and signalled expansion (Wood. 2011). 2.3.3 DIVIDENDS PER SHARE Dividend per share is amount paid to the shareholders and ratio represent the growth rate of the company’s dividend payout which aid investors in making investment decisions. The trend developed below is telling the different story than other indicators. The company stopped paying dividend in 2008 and restarted it as a strategic objective in 2011 as a result of refinancing by debt reduction which reduced cost by almost one third (O’ Doherty, 2010). The consistency in paying dividend despite of declining earning is a strategy adopted by mature companies and analysts demand exploring intends for such consistency (Schwartz, 2013). Also this consistency is supported by the reduced number of shares as a result of buyback. 2.4. LIQUIDITY RATIOS 2.4.1 CURRENT RATIO The ratio aids in measuring the ability of the current assets of the firm within the market to payoff liabilities. It assesses the performance of the company in managing working capital by assessing the liquidity of current assets. Company improved liquidity by reducing the short term debts considerably from £546 million in 2010 to £199 million in 2013 (Morning Star. 2015). 2.4.2 QUICK RATIO Quick ratio suggests more transparent ability of the company to pay off its current liabilities via current assets excluding inventory. The scenario for the company’s quick ratio is quiet fluctuating and shows ill liquid position as wide section is stuck in the inventory. The fluctuation in trend is mainly due to fluctuation in short term debts. (AR 2014). While high inventory levels often charges to company has business is then required to slash prices and discount which affects profitability; and is so happening with Debenhams (Telegraph. 2011) 2.5 EFFICIENCY RATIOS 2.5.1 ASSET TURNOVER The ratio measures the potential of company’s assets to generate sales; hence reflecting efficiency. Management utilizes the mentioned ratio in order to judge the process efficiency of organization in comparison to the industry and usually higher is better. The rise in the ratio is mainly contributed by the increase in sales as well as reduction in total assets in 3.31% in 2011. Since then it is hanged around 1.08. The issue is linked with matter that almost 10% of company’s UK stores are accounted for wasted overcapacity. It is important to mention that company has the potential as the industry is standing on the ratio of above 2 (CSI Mmarket. 2015). 2.5.2 INVENTORY TURNOVER The ratio is utilized to estimate the inventory replenishment over a particular period of time for annual cost goods sold (or from sales in case). Inventory turnover does not have any stated rule of thumb as excessive high or low ratios both are questionable. Attempting to get closer to the industry average of 5.42, company is continuously reducing its inventory turnover (CSI Mmarket. 2015). This at one place is advantageous as the company has reduced dependence on inventory which later requires price-cuts for leftover. Alongside, massive reduction in inventory is leading to higher the distribution cost which is negatively impacting the earnings. Hence, business needs to explore and strike right balance to achieve optimal cost point. 2.6 FINANCIAL LEVERAGE Solvency of the business is gauged using financial leverage ratios. Assessment of the business leverage gives idea about the impact generated on the business earnings due to finance cost incurred. 2.6.1 Long term debt / Equity Long debt to equity assesses the capital structure of the firm with respect to debt and equity portion. The proportion of long term debt to equity has increased as the company increased long term debt from £41 million to £243 million pounds noting an increase of 463% straight and later in 2012 to 2013 Debenhams stated reducing debt by small portions. This measure by the company creating is creating a form of u trend in the long term debt to equity. Understanding of its impact can be further revealed through interest cover ratio discussed below. 2.6.2 INTEREST COVER The interest coverage ratio is another stringent test to assess the ability of the business to acquire further debt. It is take ratio of earnings before interest and taxes to the interest expense incurred by the company. The ratio is of significant importance for the potential debtors. For the underlying company, the interest coverage ratio has increased considerably. This is despite fact that business has acquired the long term debt but has released a considerable portion of the short term debt (which bank borrowings) from 546 to 167 straight from 2010 to 2011 and further declined (Morningstar. 2015). Increase in the short term debt of the company in 2014 has again pulled the interest cover down. This point to fact that that short term debt of the company is being acquired from costly source. 3.0. CORPORATE GOVERNANCE OF DEBENHAMS The corporate governance as the name implies are the rules, procedures and practices which govern the performance of the business. It is centrally directed to maintain the business direction in the interest of all the direct and indirect stakeholders of the business. Debenhams gives due consideration for the effective corporate governance and its conduct is found aligned with the Listing Rules of the UK Listing Authority and the Corporate Governance Code. The annual report also provides comprehensive review of the corporate governance conduct of the business the clear direction for the board of directors, their respective responsibilities towards business, diversity and system of conflict of interest dealing, performance evaluation and the relationship with the investors are al highlighted (Annual Report. 2014). For instance, the year round activities of the board of directors are presented in the given schedule: (Annual Report. 2014) Despites these aspects widely recognized in the annual report, the company is charged with failure in effectively meeting the corporate governance liability of shareholders interest. To deeply review the performance of the company, the corporate governance rating of the company from Moody’s is assessed. The Ba3 corporate family rating (CFR) assigned by the Moody’s entails about the established and sustained position of the company in the market which is also enjoying notable presence and high level of visibility in the retails market of UK. The rating accounts diversified portfolio that is being offered by the firm and its growing sales on the comparatively new channel of online system on the international world. Moody’s rating though not affected by the profitability challenges due to challenges in the sectors; the rating agency has subsequently made recommendation to the company to focus higher on the improving profits while taking account the seasonal factors in inventory management. Alongside, the rating agency has pressed the company to improve its performance with respect to the CAPEX (assets) utilization along with the conservative financial policy in order to retain in the rated category (Moody’s.2014). 4.0. SHARE PRICES PERFORMANCE AND INVESTMENT ADVICES 4.1 NET ASSET VALUE PER SHARE The Net Asset Value (NAV) per share, as also it is known as the Net worth of the company implies per share net asset (or assets- liabilities) of the firm. It is often measured with respect to the intangible assets of the firm with respect to liabilities and has been conducted so for the underlying company. The negative NAV of the company is the representative of the fact that company will not be able to satisfy creditors even by selling all of its tangible assets. Important to mention is the fact that industry is reducing its NAV due to the challenges posed by the retail industry; Debenhams has improved its position from £26.64 to £-9.85. However still there exists considerable difference that needs to be filled; though prospects do not seem to be favoring company (Jackson.2014). Despite this fact and company’s tangible assets improving, the complex structure of the liabilities is questionable. Hence, Source: London Stock Exchange (2014) 4.2. SHARE PRICES The share price is the price which investors assign to the company’s stock based on the investors’ assessment of the company’s current performance as well as future prospects. Different theories are put forward to enlighten factors which in turn produce share price of the company in the capital market. Some of the concepts include random walk theory which entails that share price is simply the random assigning of value to the shares of the company in the capital market. On the other hand, the share price performance is attributed to combination of the fundamentals’ performance in addition to the behavioural finance claiming that share price also receives impact from the behavioural aspects of the investors. Hence, collectively various factors result in developing the share price of the firm. Source: Yahoo Finance (2014) The share price of the company outperformed the market in 2012 owing to the fact that company showed considerable growth as compared to its leading competitor. However, it is also evident that company’s losing its competitive front is also evident in the share price post 2013 (Head, 2012). The current situation is further complicated by the limited growth and challenges present in the industry. Contrary to competitors like Marks and Spencer and Next Plc, the challenge is increased by the fact that offerings by the company require discretionary spending. Also the target market segment does not include compulsive buyers who are young and are influenced and attracted by regular cheap offerings as well as brand conscious people. P/E multiple has though improved despite of these challenges; it may be attributed to the attractive dividend policy. Hence, owing to the challenges posed to the industry and vulnerable position of the firm, it is recommended not to invest in the company upfront. Instead wait and watch how the company capitalizes improving economic conditions. This suggested is aligned with the analysts forecast on Financial Times who earlier had consensus on buy, hold and outperform stance for the company (Financial Times. 2015). 5.0. CONCLUSION Debenhams a renowned retails company in the service sector has been analyze in the report. Based on the five years performance of the company with respect to business conduct, an investment related advice not investing in the company has been formulated. This investment advice is backed by the fact that the company is assessed to lose its competitive position in the industry which is full of challenges and have limited growth. List of References Annual Report. (2013). Debenhams plc. Available from: http://media.corporate-ir.net/media_files/IROL/19/196805/agm2013/ar2013.pdf. [Accessed 2 January 2015]. Annual Report. (2014). Debenhams plc. Available from: < http://media.corporate-ir.net/media_files/IROL/19/196805/agm2014/annual_report_and_accounts.pdf . [Accessed 2 January 2015]. Business Teacher. (2014). The UKs Leading Provider of Free Business Study Resources. Available from: Read More