(Bloomberg Gadfly) -- Billionaire Mike Ashley might finally get the chance to add a department store to his Sports Direct International Plc stable.
Debenhams Plc confirmed on Thursday that it had a difficult Christmas, with a warning that if current conditions continued, full-year pre-tax profit would be between 55 million pounds ($74.5 million) and 65 million pounds, compared with the Bloomberg consensus of 82 million pounds.
After Next Plc's somewhat muted optimism on Wednesday, this brought the retail sector down to earth with a bump.
It also took a chunk out of the Debenhams share price, sending it down by about 17 percent to just under 30 pence. When Ashley first took an interest in Debenhams, in January 2014, the retailer's shares were trading at about 80 pence.
Of course, Ashley's 21 percent stake in Debenhams will also have fallen in value after Wednesday's profit warning. But buying in the remainder of the department store that Sports Direct doesn't own -- if it wanted to -- just got a lot cheaper too. Debenhams' market capitalization has shrunk from about 1 billion pounds in January 2014 to about 365 million pounds.
Debenhams' problems this holiday season were largely sparked by having too many run-of-the-mill Christmas gifts, which it had to discount to encourage shoppers to buy. That made it more difficult to stop its perennial special offers, which is one of its longstanding problems. This doesn't bode well for rival House of Fraser. Its selection might not necessarily have been the same as Debenhams, but it won't have escaped the difficult trading conditions in the run up to Christmas and the need to promote. It was advertising special offers in the days ahead of the festive season.
This could present Ashley with a potential decision to make -- Sports Direct has an 11 percent stake in House of Fraser's U.K. business. While difficult conditions for U.K. retailers are not good for the value of his own investments in Debenhams and House of Fraser, it does give him the option to pick up a department store on the cheap, if he wanted to.
Even though department stores are struggling, they would fill a strategic need for Sports Direct. Ashley's long eyed a department store to help him achieve a goal of adding a more upmarket product range, and so encourage the big sportswear brands to supply him with their most-premium products.
There's a question mark over whether he would make any move, however. Sports Direct's own financial flexibility has been crimped over the past four years, as its borrowings have been swelled by overhauling its shops and buying back shares. The concessions he's had in Debenhams haven't worked out that well, either.
Still, there's no need to hurry. It's hard to see Debenhams shares sparking a big rally, or another buyer coming in. Debenhams is making progress in areas such as clothing, but improving its products will take time. It is aiming to make the business more efficient and says it could shut up to 10 stores. It should go further. Even if it does accelerate closures, change here won't come quickly either.
It will struggle to improve one of the lowest operating margins in the sector. Although debt has come down a lot, it still has a burden to contend with. Borrowings are forecast to be 1.4 times Ebitda at the end of the current financial year.
It will take a view on the dividend at the half year stage, but there is a possibility it will be cut. A prospective dividend yield of 10 percent looks unsustainable.
The shares trade on a forward price earnings ratio of 5.4 times, around half the level of Marks & Spencer Group Plc and Next. Until Debenhams can wean itself off of the drug of discounting, there is little prospect of a rerating.
Like a shopper choosing a new dress in the January sales, Ashley has plenty of time to decide whether to make a move, and if so, whether Debenhams or House of Fraser is a good fit.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.
To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.
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