Debenhams – to CVA or not to CVA?
Debenhams’ appointment of external advisors fans the flames of doubt, solid retail sales figures for August from the BRC, a positive trading update from Primark and a record half year from JD Sports.
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- Far from disastrous retail sales figures from the BRC for August. Like-for-like sales improved 0.2% year-on-year in the four weeks to 25 Aug, with total sales up 1.3%. An inevitable slowdown on the growth rates of the previous two months, when the weather was far better. Performance remains very polarised by sub-sector, with grocery continuing to outperform non-food.
- A positive post year-end trading statement from Primark, ahead of its full-year results announcement on 6 Nov. The value fashion operator saw full-year sales rise 5.5% on a constant currency basis, despite a 2% decline in like-for-like sales internationally. The UK business was more robust, with total sales up 6% and like-for-likes up 1.5%. Group operating margins for the full year will be around 11%, versus 10.4% the previous year. Selling space rose by 0.9 million sq ft this year through 15 net new store openings. It now has 360 stores trading from 14.8 million sq ft, compared to 13.9 million sq ft a year ago.
- Record half year sales and profits at JD Sports. The sports fashion retailer posted a 19% jump in pre-tax profits to £121.9m for the 26 weeks to 4 Aug, driven by 35% growth in revenue to £1.8 billion. Although the top-line figure was boosted by a 7 week contribution from the newly-acquired Finish Line business in the US, like-for-like sales nevertheless increased by a healthy 3%. The retailer opened a net of 44 new JD Sports stores during the period, 39 of which were in international markets. It ended the period with 390 JD Sports stores across the UK and Ireland and 2,184 across its multiple sports fashion fascias and territories.
Stephen Springham, Head of Retail Research:
And so the spotlight again falls on Debenhams, with news emerging that it has appointed KPMG to advise on strategic options. Most interpreted this as a precursor to a CVA, which Debenhams has subsequently strenuously denied.
Will Debenhams launch a CVA / should Debenhams launch a CVA? Two very different questions, to which I have two very different answers – conceivably yes / categorically no. Chairman Sir Ian Cheshire has laudably come out fighting in an attempt to reassure markets that it is in fact exploring “every option”, that an impending CVA “is simply not true” and the business was “not insolvent”.
But judging by the City and media reaction, many are still not convinced and continue to view a CVA as a foregone conclusion. Sir Ian’s analogy of “nosy neighbours” perhaps erred on the side of kind – “a wolfpack ghoulishly baying for blood” wouldn’t be wide of the mark.
How has it come to this? Cue the usual media ‘talking heads’ falling back on lazy assumptions such as a depressed consumer environment and the inexorable rise of online.
A consumer that is on course to spend at least 4% more on retail this year than last, with the additional tailwind of earnings growth again outstripping inflation? Debenhams defenceless prey to online machines, when it is itself a strong multi-channel player?
Consumers shop retailers and brands, not channels. The mainstay of Debenhams’ product range is own-label, especially on the fashion side – by extension, it is exclusive to Debenhams, Debenhams is the only place that stocks it. If Debenhams is losing out to pure-play fashion retailers such as ASOS and boohoo, the issues are product- and brand-based, rather than channel-orientated.
The die was actually cast many years ago, specifically in the 2000s (if not before). As with virtually all CVA cases, the finger can be firmly pointed at private equity. Debenhams was purchased by a private equity vehicle called Baroness Retail in 2003. Baroness Retail comprised CVC Capital Partners, Texas Pacific Group and Merrill Lynch Global Private Equity.
Under their ownership, £66m was raised through the sale of freehold property and £150m was paid as a dividend. The business also embarked on an overly-aggressive debt-backed expansion programme, before floating at 200p a share in 2006, valuing it at £1.7bn. Highly geared with too many stores, many of which were over-rented, is hardly the sturdiest foundations for any business, least of all one exposed to the unforgiving nature of the UK retail market.
But I maintain that Debenhams should not pursue a CVA on two counts. Firstly, because CVAs should only be the preserve of retailers that are fully distressed, rather than merely under-performing.
The unexpected trading update that was issued on Monday to diffuse media concerns highlighted that full-year profits were likely to short of (previously downgraded) guidance of £35m - £40m, but within the analyst range of £31m - £36.5m. Whatever the bar of expectation, the fact remains that Debenhams is still profitable as a business and the vast majority of its stores are also in the black at trading level.
Sure, it is not massively profitable, margins are very slim and the trend is negative, but any bid to launch a CVA will inevitably be met with resistance on the part of many landlords on the grounds of abuse of the system.
Secondly – and more importantly - I believe Debenhams should best avoid a CVA for its own sake as much as for anyone else’s. CVAs have become seemingly so commonplace that they are viewed as a soft option. However, the reality is very different.
On the one hand, drawing them up and executing them is a very expensive business – check out the exceptional costs that Carpetright booked in its latest accounts. And over and above the high costs (which surely would be better employed as either capex or working capital), there are also huge intangible downsides of going through the CVA process. Credibility and trust with landlords and suppliers may never be fully restored and worse still, the overall brand may be left tarnished with those that matter most – customers.
Customers shop brands. CVAs drag brands through the dirt. By launching a CVA, retailers may actually be alienating those that are actually essential for its survival, namely its customers. Maybe embark upon proactive, honest, two-way, meaningful discussions with landlords rather than give them a ‘take it or leave it’ ultimatum in a CVA. Possibly achieve the same end result and emerge with your brand in tact. A retailer with brand equity has a far better chance of survival than one with none.