Debs gets back into shape as sales grow

Profits hit £131.4 million in the year to 1 September - slightly above forecasts which were reduced several times as the department stores chain endured one of the rockiest periods in its history.

Like-for-like sales tumbled 5% as the group scrambled to update its product offering and shake up its old-fashioned image.

But trading in the last few weeks has been strong, with like-for-likes up 2.1%, helping Debenhams' market share improve from a weak position.

Chief executive Rob Templeman admitted his company is improving just as the entire retail industry faces a downturn.

"Despite wider concerns about the macro-economic environment and how this will impact on the retail sector, we are confident that the changes we are making are benefiting the business," he said.

Templeman is refitting the group's 135 stores and has brought fresher brands, such as Ted Baker, into the mix.

The shares rose 6p to 109½p, welcome relief to investors who bought the stock when it floated in May 2006 at 195p and have endured three profit warnings since December.

Finance director Chris Woodhouse said: "We have had a difficult year but we've put a lot of effort in and are quietly confident about trading going forward."

He acknowledged now may not be the time to embark on a big expansion, given signs of a fall in consumer confidence. "We are conscious of that and will be cautious in terms of planning going forward. It will be about market-share gains," he said.

Some City analysts have raised fears that the dividend is vulnerable, but Woodhouse said: "I've read the articles but I don't understand where they are coming from. We are highly cash-generative."

A dividend of 6.3p a share will be paid, a little more than expected. Debenhams also managed to pay down £80 million of debt, leaving it with borrowings of £1 billion.

Analysts said the numbers were decent, but point out that they compare with a torrid period. Dresdner Kleinwort said in a note: "Looking into 2008, like-for-like sales trajectory is also deeply uncertain."

Debenhams was seen as perhaps the worst example of what happens when private equity takes control of a business. CVC, Texas Pacific and Merrill Lynch took the business off the stock market and re-floated it at a price that now looks highly optimistic. Almost as soon as it rejoined the stock market it ran into intense competition from a rejuvenated Marks & Spencer.

At today's price the whole company is worth £880 million, though at this stage it seems unlikely to attract a takeover bid. Icelandic group Baugur has a 12.5% stake and would be the most likely to make an overture.

But talk persists that private-equity houses which hold 28% of the equity will take the group private once more.

Analyst note from Landsbanki:

Debenhams reported full year results to end August today broadly in line with previous indications given at the year-end trading update on 18 September. We are leaving our estimates unchanged and retain our Hold rating.

After a very difficult year in which like-for-like sales were down 5%, the first seven weeks of FY2008 has seen an improving trend with
like-for-like sales up 2.1%, despite refurbishment disruption – gross margins are also higher. However this improvement is difficult to interpret because the comparison was weak (LFL -4.2%) and recent weather has been goodfor clothing.

Even more problematic is the uncertain consumer outlook; while we are currently assuming zero like-for-like sales growth through to September 2008, it seems quite possible that this could be too optimistic and we continue to see forecast risk. This risk is magnified by the
financial leverage (fixed charge cover is 2.2 times versus 2.8 times for the sector).

Moreover, although operational gearing is close to the sector average, it is higher than most stocks on our buy list and the sector is
comparatively geared relative to the market.

The valuation continues to run below sector norms (c. 35% P/E discount, c. 10% EV discount). A return to 2006 margins would suggest substantial upside potential in the share price, particularly if combined with a valuation closer to the sector average.

While we view a return to these margins as credible, the equity market tends to want a bit more evidence of the turn than a few weeks of cold weather and a return to previous levels will likely require a better spending environment than we expect.