It’s never good to see one of your holdings deliver a profit warning, perhaps less so, when it comes on the back of a previously announced positive update to the market.
Such was the case for me yesterday with Gear4music (G4M) which following announcing its Interim results, Brokers downgraded expectations for the current full year and perhaps surprisingly the subsequent one too.
Ouch! springs to mind and prior to the open I had already assumed a mark down anywhere between 15%-20% which proved about right, as although the shares retraced by 22% at one point, they closed 18% lower at £6.80p.
Having enjoyed a spectacular run on this investment from my entry point at £2.85p last year, it is always tempting to take your profit and move on and no doubt some would have elected to do so.
However, for me, this is no falling knife situation and I was actually actively hoping to buy a few more yesterday, as I believe the business is in a good spot and has excellent mid-longer term growth potential.
Although I was, as it transpired, unable to add at the price I had set yesterday, I shall nevertheless keep close tabs on any downward movement, as after catching up with the CEO Andrew Wass and CFO Chris Scott once more yesterday, I remain convinced on the prospects of the company going forward.
G4M is the UK’s leading online retailer of musical instruments and associated products such as sound systems and decks and features in the top three players across Europe.
It may sound like something of a cut throat business, with detractors perhaps (and wrongly in my view) assuming that the likes of Amazon are far better placed to execute in such a market. But, given the many products and customer requirements, then a pure online specialist should have a bright future.
G4M as many will no doubt know enjoyed an excellent full year 2021 which was largely driven by the various lockdowns which returned record results for the company, although that performance was always going to be a one off and this was stressed as much on more than one occasion.
Despite the inevitable reduction in revenue and profits for the year in progress, the company did however announce a positive update for the first quarter of the year, where at the time it stated that trading was running ahead of expectations.
But, like many turns on the stock market merry-go-round, the company subsequently in September flagged up that Brexit induced challenges had impacted European sales along with supply chain issues, perhaps in hindsight sounding a warning note of what may lie ahead.
Speaking of that situation Wass commented that they had been aware of the potential for disruption and actual Brexit related issues for some time and had very much been taking steps to mitigate downside.
“If you look at last year”, Wass said, “you can see that we were already decreasing on the orders coming out of the UK for Europe, but increasing them directly within Europe. We recognised then, that we were going to have to do more than just scale up on our existing European hubs”.
That led us to open up our two new European one's which opened on time and began shipping and delivering goods in September. The issue has been however, that it in the current environment it has been more challenging to get those really scaled up and as quickly as we wanted to.
Going on the CEO adds, “for example, containers coming in from the far east, the container deliveries and all this sort of thing are all just taking that much longer. We are scaling up though and relatively quickly and we had wanted to do it as quickly as possible as we know this is the solution to the problem.
So yes, we are scaling up now and by Q4 we will be firing on all cylinders hopefully, with that really making a meaningful contribution”.
Speaking of the slippage in numbers, Wass adds, “the Q3 softer sales is a real shame, as if it had just been two or three months further in progression of the new hubs, then we wouldn’t even be having this conversation, but unfortunately, it is what it is”.
Whilst the news is obviously unwelcome, Wass sounds very positive on the forward picture where he says “we have so many things going on for next year, the business is in great shape and we are cracking on with those now”.
One aspect of this relates to the recently acquired AV business to which Wass comments, “I’m really very excited about this, which when I first looked at it, I thought, this is us from about ten years ago. As a result, we know how to really accelerate this business and fast forward it and put it on our platform which is much more advanced”.
Wass also says that AV’s market is not dissimilar to G4M’s with a lot of similarities and shared suppliers so the plan is to apply a lot of the lessons that they have learnt along the way to the newly acquired business and accelerate that as quickly as they can.
“It’s obviously a domestic UK business at the minute, but when we launch this in January on our platform as AV.com this will start off as a domestic business, but then fairly quickly the plan is to turn on a European platform and start retailing into Europe as well as the UK.”
The CEO sounds bullish on what can be done and subsequently achieved with what is at present a relatively small business and says that the market is really ready for what they plan to do in the space and that they are super excited about the launch.
There is also the previously mentioned second hand offering due to come on stream next year and Wass says this is progressing well, although much of the focus has recently been on the AV proposition.
The reasoning for the AV concentration has been due to the results expected from this integration to be faster and pretty much instantaneous, although the second hand platform has seen a lot of attention applied in-house and that will be launched as planned next year, most likely now in the summer.
With the traditionally busy Christmas trading period now upon us Wass says that they are in a good place with stock, having built up their inventory in recent months.
The challenge however, as highlighted in the market statement is moving that stock on and the CEO says it’s a difficulty moving that into Europe, hence the difference the new hubs in Ireland and Spain will now make going forward.
Emerging from the pandemic has also seen some shift in the various products and Wass says that has largely played out as they expected with a 48% increase in PA system sales.
In terms of margins on products these have maintained the improvements which came following the 2019 low point and are running at 28%, although own brands which account for 25% of sales enjoy margins considerably higher at 45.7%.
Maintaining margins is key to the company and although there are not surprisingly price increases to contend with, these are quickly built in and passed on says the CEO.
Within the Interim results, there were 404k active customers during the period, with further evidence of increased usage across the mobile platform mode which now makes up 65% of all users.
Revenue for the period came out at £64.7m and £4.8m of EBITDA, whilst operating profit delivered was £2.4m.
With so much on which to concentrate and already in the pipeline the CEO dismisses my suggestion of any impending move into the US for now and says although they do look at it from time to time, anything emerging on that front is probably some three years down the line.
Although brokers such as Singer and Investec have reduced their full year forecasts, these do look conservative and whilst seemingly siding with caution they also do not include anything from the AV purchase which is not officially completed until next month.
For now, both arrive at similar numbers, with Investec looking for full year 2022 revenue at £148.8m with EBITDA of £12m and Pre-tax profits at £5.3m.
This gives EPS of 18.5p rising to 29.8p next year, which sees the stock trading on a forward (2023) PER of 22.
Given the benefits now set to come through from the new European hubs and the expectance of some easing in the supply chains, plus the AV upside, then it would come as no surprise to see those numbers revisited in due course which suggests the shares are very much worthy of my holding, or adding at a lower price.
G4M remains very well placed in a fragmented market that has and is shifting ever more to the online format and the longer term growth prospects appear firmly intact, which could see the shares returning Northwards in due course.