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Gear4music Holdings — Robust finish and forward momentum

Gear4music Holdings — Robust finish and forward momentum

Gear4music Holdings (G4M) finished the year in robust style, with 43% revenue growth. While marginally below our forecast, this represents good momentum going into FY19, where we only forecast 27%. While continued investment in scale means costs remain at planned levels, resulting in a pause in FY18 earnings growth, prospects for further market share gains remain bright and we see the current share price as below fair value.

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Written by

Gear4music Holdings

Robust finish and forward momentum

Year-end trading statement

Retail

6 March 2018

Price

631p

Market cap

£132m

Net debt (£m) at August 2017

3.7

Shares in issue

20.9m

Free float

64%

Code

G4M

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.6

(10.5)

(3.7)

Rel (local)

4.2

(8.1)

(1.7)

52-week high/low

865.0p

502.5p

Business description

Gear4music is the largest dedicated, UK-based online retailer of musical instruments and music equipment. It sells branded instruments and equipment, alongside its own brand products, to customers ranging from beginners to professionals, in the UK and into Europe and the rest of the world.

Next events

Preliminary results

May 2018

Analysts

Paul Hickman

+44 (0)20 3681 2501

Neil Shah

+44 (0)20 3077 5715

Gear4music Holdings is a research client of Edison Investment Research Limited

Gear4music Holdings (G4M) finished the year in robust style, with 43% revenue growth. While marginally below our forecast, this represents good momentum going into FY19, where we only forecast 27%. While continued investment in scale means costs remain at planned levels, resulting in a pause in FY18 earnings growth, prospects for further market share gains remain bright and we see the current share price as below fair value.

Year end

Revenue (£m)

EBITDA
(£m)

PBT*

(£m)

EPS*
(p)

P/E
(x)

EV/EBITDA
(x)

02/16

35.5

1.7

0.6

3.1

201.8

76.7

02/17

56.1

3.7

2.7

11.6

54.3

37.1

02/18e

80.1

3.7

1.7

7.3

86.7

37.1

02/19e

102.1

5.0

3.1

12.5

50.3

27.4

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Strong revenue growth, momentum sustained

G4M has traded strongly throughout FY18, with a 39% increase in active customers and a 3.25% conversion rate. Against an atypical base in FY16, 41.7% revenue growth for September-December 2017 was a very satisfactory result. In January and February 2018, growth has remained consistent at a robust 41.3%, representing acceleration against 38.7% in the previous year. This provides good momentum going into FY19.

Investment in scale continues

Having raised £4.2m net cash in May 2017, G4M has continued to develop its platform, build the management structure, and expand stock range and availability. The European distribution centres that opened last year have scaled up, marketing activities continue to develop, and FY18 bears the costs of moving into the freehold office in York as well as the financing costs of the freehold base.

Forecasts: FY18 pause, confident in FY19e

Reflecting operational gearing in the business, combined with management’s commitment to investing for scale, a shading of FY18 revenue against our forecast is likely to have a disproportionate effect on earnings. Management guides to EBITDA similar to FY17 and we reduce our FY18e forecast from £4.1m to £3.7m. However, we do not expect a significant implication for FY19e, where we remain confident in our forecast, based on sales growth well below the current level.

Valuation: Upside on both our metrics

G4M stands at a P/E discount and a slight EV/EBITDA premium to online retail peers. Adjusted to the average for both, G4M would be valued at 707p. On a DCF basis, we estimate that G4M’s current share price implies around nine years to reach market share of 6% in mainland Europe, starting in FY19. It took six years to build that market share in the UK and if G4M can replicate that in Europe, the appropriate share price valuation would be 831p, or if it took seven years, 726p. On both metrics, therefore, we see share price upside.

Trading update: A good finish to a strong year

G4M has continued to trade strongly throughout FY18:

Exhibit 1: Consistent sales growth

£000

Mar-Aug

Sept-Dec

Jan-Feb

FY

FY18

UK

17,900

18,763

7,595

44,258

Europe and RoW

13,319

15,801

6,722

35,842

Total

31,219

34,564

14,317

80,100

FY17

UK

13,784

15,019

6,062

34,865

Europe and RoW

7,825

9,365

4,073

21,263

Total

21,609

24,384

10,135

56,128

Growth in FY18

UK

29.9%

24.9%

25.3%

26.9%

Europe and RoW

70.2%

68.7%

65.0%

68.6%

Total

44.5%

41.7%

41.3%

42.7%

FY16

UK

9,584

11,608

4,824

26,016

Europe and RoW

2,909

4,082

2,482

9,473

Total

12,493

15,690

7,306

35,489

Growth in FY17

UK

43.8%

29.4%

25.7%

34.0%

Europe and RoW

169.0%

129.4%

64.1%

124.5%

Total

73.0%

55.4%

38.7%

58.2%

Source: G4M

Substantial and broadly based growth

Growth has been substantial strong and broadly based, built on a significant 39% increase in active customers. Europe continues to run ahead of growth rates in the more mature UK market, with Scandinavia making a particular contribution. We understand that sales through mobile devices has been a recent success and look forward to further detail at the final results in May.

From a seasonal standpoint, triple-digit European growth in the first half and third quarter of FY17, driven by the competitive advantage around sterling’s devaluation in mid-2016, was something of a one-off, although it was utilised by management to drive strategic advantage in opening up these new target markets. Against that background, growth of 41.7% in September-December 2017 was a more than satisfactory result, albeit slightly lower than first-half growth largely as a result of slight flattening of the UK growth rate, still strong at 24.9%.

Early 2018 momentum remains strong

Moving into January and February 2018, growth has remained consistent with the previous period at a very robust 41.3%. Internationally, the dramatic growth seen earlier in the year (70% in H1) reduced very slightly to 65%, which indicates that market share gains are continuing strongly. In the UK, growth remained consistent at 25.3%, which is very pleasing considering that this is a characteristically weak period and UK retail sales volumes had been much lower than expected in January at 1.6% volume and 4.4% value year-on-year (source: ONS). In total, the last two months’ growth of 41.3% remains very consistent with the previous four-month period, reinforced by the greater weighting of international sales, now 47% of the total against 40% for the same period in the previous year. This final two months, in fact, is ahead of 38.7% growth in the previous year.

In short, G4M’s top-line performance has been excellent, and momentum is being sustained. Sales expansion has been strong and market share continues to be won, particularly in the newer markets of Europe where so much strategic focus has been concentrated. If there is any disappointment, it is that the pick-up in the final two months was not greater, despite the weakening of growth in the final two months of FY17. As a result, revenue for the year was 1.6% below our forecast at £81.4m.

Current developments: Positive indications

Among other positive indicators for G4M as it finishes its FY18 year are:

■

Conversion across all websites has increased from 2.75% to 3.25% year-on-year. This is a high-quality score in a key conversion rate, which provides evidence of the quality and effectiveness of the company’s online marketing.

■

Mobile ordering is seeing good traction, we understand. In H118, the company reported a 61% increase in mobile visitors to 3.8m. We look forward to further updates.

■

Progress on consumer credit. In the UK, G4M offers retail point-of-sale credit through an agreement with an external credit provider. The company is changing its provider and plans to roll out the product in Europe.

Investment in scale

G4M continues to invest for future scale. Having raised £4.2m net cash in May 2017, the company has continued to develop its platform and build the management structure. We noted increased stock investment in the first half, intended to improve range and availability. Although the European distribution centres in Sweden and Germany were both opened by the beginning to this financial year, stock investment and operational costs there have continued to support revenue growth as expected. Marketing activities, which were running at 8% of revenue at interim, are continuing to develop, and FY18 bears the costs of moving into the freehold office in York as well as its financing costs.

Forecasts: Confident in FY19 revenue growth

As a result of the significant operational gearing in the business, combined with management’s unchanged commitment to investing for scale, the marginal shading of FY18 full-year revenue against our forecast is likely to have a disproportionate effect on earnings. However, we do not expect that to affect FY19 or FY20 significantly, where we believe our forecasts remain prudent.

Exhibit 2: Changes to forecasts

FY18e

FY18e

Change

FY19e

FY19e

Change

Growth

FY20e

FY20e

Change

Growth

£000

Old

New

%

Old

New

%

%

Old

New

%

%

Revenue

81,410

80,100

(1.6)

102,116

102,113

(0.0)

27.5

127,347

127,282

(0.1)

24.6

EBITDA

4,092

3,652

(10.8)

5,150

4,953

(3.8)

35.6

6,664

6,669

0.1

34.7

Normalised operating profit

2,648

2,160

(18.4)

3,589

3,391

(5.5)

57.0

4,746

4,747

0.0

40.0

Operating margin

3.3

2.7

(17.1)

3.5

3.3

(5.5)

0.6

3.7

3.7

0.1

0.4

Profit before tax (norm)

2,360

1,720

(27.1)

3,325

3,127

(6.0)

81.8

4,482

4,483

0.0

43.4

EPS (p)

10.0

7.3

(27.1)

13.3

12.5

(6.0)

72.2

18.0

18.0

0.0

43.4

Net cash/(debt)

(3,852)

(3,509)

8.9

(4,680)

(4,367)

6.7

(24.5)

(4,856)

(4,541)

6.5

(4.0)

Source: Edison

In the second half of FY18, revenue was very slightly lower than our forecast, mainly because the rate of growth in the final two months did not increase, despite a relatively weaker base in the previous year. We reduce our EBITDA forecast to £3.6m, flat compared with FY17 and in line with management’s guidance. We also include gross margin slightly lower at 25.6% against our previous forecast of 25.8%, and translational currency differences.

At this stage, we remain very confident in our FY19 revenue forecast of £102.1m. It represents 27% growth against FY18, significantly lower than the growth actually experienced in January and February. A 3% trim to our EBITDA forecast is the result of our assuming that a 0.2 percentage point reduction in gross margin carries on through FY19. We expect net debt slightly lower than our previous forecast as a result of working capital requirements at lower levels.

Valuation: Upside on both our metrics

We retain our valuation approach, referring both to peer multiples and our DCF projections:

Peer group valuations

Short-term P/E and EV/EBITDA multiples now stand at a significant discount to the average P/E of pure-play online retailers, while close to their average EV/EBITDA multiples. On an EV/sales basis, G4M stands at a significant discount in both years:

Exhibit 3: Comparative peer valuations

Year end

Market cap (m)

EV/sales

FY19e (x)

EV/sales

FY20e (x)

P/E

FY19e (x)

P/E

FY20e (x)

EV/EBITDA

FY19e (x)

EV/EBITDA

FY20e (x)

ASOS

August

5,896

1.9

1.5

65.2

52.1

30.3

23.7

Boohoo

February

1,955

2.3

1.7

48.6

37.8

25.8

19.1

Yoox Net-A-Porter

December

5,085

1.8

1.5

63.8

45.6

22.3

16.8

Zalando

December

10,549

1.4

1.2

63.5

49.4

27.4

21.5

Average

1.8

1.5

60.3

46.2

26.5

20.3

G4M

February

1.3

1.1

50.4

35.2

27.3

20.3

Premium/(discount)

(28.2%)

(28.2%)

(16.4%)

(23.9%)

3.3%

0.0%

Source: Bloomberg, Edison. All calendarised to February.

Adjusted to the average of the peer group for the FY19e and FY20e years on a P/E basis, G4M would be valued at 793p per share, or 622p on an EV/EBITDA basis, an average of 707p.

DCF valuations

On a reverse DCF basis, we estimate that, under consistent assumptions, G4M’s current share price (which is now about 25% lower than it was in October 2017) implies around nine years to reach market share of 6% in mainland Europe starting in FY19, equivalent to that which it currently enjoys in the UK (we previously estimated six to seven years). It effectively took six years to build this level of market share in the UK, from insignificant levels. Therefore, if G4M takes less than nine years to develop this market share (at constant economic ratios), then there is a share price opportunity. For example, if it achieves it in seven years, that would be equivalent to a share price valuation of 726p, or if in six years, 831p.

European expansion is now a major strategic focus for G4M, which is also better organised, resourced and experienced than it was when it began to build its share of the UK market. In addition, it has the benefit of the May 2017 placing, which raised £4.2m of additional growth capital specifically aimed at accelerating expansion. On the other hand, it is true that there is more organised online competition in mainland Europe. G4M needs to negotiate the enhanced risks of setting up operations in different geographies, although it has made significant progress with its centres in Germany and Sweden.

Exhibit 4: Financial summary

£000s

2016

2017

2018e

2019e

2020e

Year end: February

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

35,489

56,128

80,100

102,113

127,282

Cost of Sales

(26,303)

(40,983)

(59,555)

(75,766)

(94,326)

Gross Profit

9,186

15,145

20,545

26,347

32,956

EBITDA

 

 

1,688

3,656

3,652

4,953

6,669

Operating profit (before amort. and except).

 

903

2,655

2,160

3,391

4,747

Amortisation of acquired intangibles

0

0

0

0

0

Exceptionals

(606)

0

0

0

0

Share-based payments

(8)

(39)

(64)

(65)

(82)

Reported operating profit

289

2,616

2,096

3,326

4,665

Net Interest

(283)

20

(440)

(264)

(264)

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

0

0

0

0

0

Profit Before Tax (norm)

 

 

620

2,675

1,720

3,127

4,483

Profit Before Tax (reported)

 

 

6

2,636

1,656

3,062

4,401

Reported tax

(49)

(322)

(206)

(500)

(717)

Profit After Tax (norm)

571

2,353

1,513

2,626

3,765

Profit After Tax (reported)

(43)

2,314

1,449

2,562

3,684

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

571

2,353

1,513

2,626

3,765

Net income (reported)

(43)

2,314

1,449

2,562

3,684

Basic average number of shares outstanding (m)

18.2

20.2

20.7

20.9

20.9

EPS - basic normalised (p)

 

 

3.1

11.7

7.3

12.6

18.0

EPS - normalised (p)

 

 

3.1

11.6

7.3

12.5

18.0

EPS - basic reported (p)

 

 

(0.2)

11.5

7.0

12.3

17.7

Dividend per share (p)

0.00

0.00

0.00

0.00

0.00

Revenue growth (%)

46.4

58.2

42.7

27.5

24.6

Gross Margin (%)

25.9

27.0

25.6

25.8

25.9

EBITDA Margin (%)

4.8

6.5

4.6

4.9

5.2

Normalised Operating Margin

2.5

4.7

2.7

3.3

3.7

BALANCE SHEET

Fixed Assets

 

 

4,477

7,102

13,718

14,751

15,853

Intangible Assets

3,238

5,537

6,094

6,612

7,083

Tangible Assets

1,239

1,565

7,623

8,139

8,770

Investments & other

0

0

0

0

0

Current Assets

 

 

11,194

16,035

20,625

23,779

28,158

Stocks

6,906

11,686

14,515

18,135

22,333

Debtors

740

1,348

1,924

2,452

3,057

Cash & cash equivalents

3,548

3,001

4,187

3,192

2,769

Other

0

0

0

0

0

Current Liabilities

 

 

(6,022)

(10,000)

(10,841)

(13,112)

(15,666)

Creditors

(5,188)

(7,379)

(7,873)

(10,044)

(12,500)

Tax and social security

0

0

0

0

3

Short term borrowings

(834)

(2,621)

(2,969)

(3,069)

(3,169)

Other

0

0

0

0

0

Long Term Liabilities

 

 

(290)

(1,415)

(5,988)

(5,343)

(4,526)

Long term borrowings

(127)

(24)

(4,728)

(4,491)

(4,141)

Other long term liabilities

(163)

(1,391)

(1,260)

(851)

(385)

Net Assets

 

 

9,359

11,722

17,514

20,075

23,820

Minority interests

0

0

0

0

3

Shareholders' equity

 

 

9,359

11,722

17,514

20,075

23,823

CASH FLOW

Op Cash Flow before WC and tax

1,688

3,656

3,652

4,953

6,669

Working capital

(1,416)

(3,618)

(2,911)

(1,978)

(2,346)

Exceptional & other

(607)

28

(64)

(65)

(82)

Tax

0

(104)

(206)

(500)

(717)

Net operating cash flow

 

 

(335)

(38)

471

2,409

3,524

Capex

(1,509)

(2,195)

(7,680)

(2,595)

(3,025)

Acquisition: deferred payments

0

0

(409)

(409)

(409)

Net interest

(130)

(47)

(440)

(264)

(264)

Equity financing

9,535

0

4,193

0

0

Dividends

0

0

0

0

0

Other

0

0

0

0

0

Net Cash Flow

7,561

(2,280)

(3,865)

(858)

(174)

Opening net debt/(cash)

 

 

4,974

(2,587)

(356)

3,509

4,367

FX

0

0

0

0

0

Other non-cash movements

0

49

0

0

0

Closing net debt/(cash)

 

 

(2,587)

(356)

3,509

4,367

4,541

Source: G4M, Edison

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DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Gear4music Holdings and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Limited (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. 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Level 12, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Research: Industrials

Datron — FY17 results: Growth continues

2017 was another year of healthy growth extending Datron’s powerful recovery following the years of economic crisis. On the basis of management guidance for the current year, the shares trade at 15.0x earnings. Further growth is expected in 2019 which could drive margins to the previous level of 10% and beyond.

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