Small Cap Value Report (Fri 5 Jan 2018) - G4M, CRAW

5th Jan '18 by Graham Neary

41 comments 15819 reads

Good morning!

Paul added further sections to yesterday 's report, which now includes:

Debenhams (LON:DEB)
Sopheon (LON:SPE)
Churchill China (LON:CHH)
Cambria Automobiles (LON:CAMB)
Walker Greenbank (LON:WGB)
Taptica International (LON:TAP)
Ethernity Networks (LON:ENET)
Be Heard (LON:BHRD)
Cyanconnode Holdings (LON:CYAN)

It's available at this link.

Today, I'm going to start by covering £G4M (Gear4Music) and Crawshaw (LON:CRAW).

Regards,

Graham

£G4M (Gear4Music)

Share price: 740p (-4%)
No. of shares: 21 million
Market cap: £155 million

Trading update

This is a fast-growing online retailer of musical instruments, which is the UK's largest.

Not having purchased a musical instrument in many years, I've just been doing a little bit of googling to see who else is prominent when you search to buy musical instruments online.

It looks like the biggest player in Europe is Thomann (external link), a family-owned German business in Bavaria. It is several times larger than G4M, earning revenues of €525 million back in 2013, according to Wikipedia. By contrast, G4M is forecast to earn £81 million in revenue during the latest financial year.

It's a fragmented marketplace. According to an Edison research note, Thomann's market share in 2016 was 13%, making it by far the largest company in the sector.

So can G4M catch up? The growth rates are certainly encouraging. Today's trading update includes the following table:

Christmas is a key buying period for G4M, making this an important update for the company's annual performance.

If I go back and compare this update versus the equivalent one from last year, growth rates last year were as follows: UK + 29%, International +129%, and total + 55%.

We can also compare against the growth rates in the interim results. In those results UK sales were +30%, International sales were +70%, and total sales were +44%.

It's easier to grow from a smaller base, of course. But perhaps today's slight reduction in the share price reflects that…

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Wol

5th Jan '18

Re: £G4M
There was some interesting comments on the Matylda I read the news today oh boy thread this morning. The one that most worried me about G4M was the suggestion that (at least some of) the same items are available at lower cost and with better delivery options from Amazon. So the question is what competitive Advantage £G4M can exert that would maintain their position and margins in the face of competition including the obvious competition from The Everything Store

GrahamF

Forgive me if I more or less repeat some of what I said on Matylda’s thread about £G4M.

Whether any of us on this thread would personally buy musical gear online is pretty much irrelevant as the company’s sales revenues clearly demonstrate there are plenty of people who will. I personally would never buy shoes online as I find it so hard to find shoes that fit but there are plenty of people that do. Boohoo’s business depends on there being plenty of people who will buy before they try. Our own purchasing preferences are a very poor indicator of whether or not a market exists for an alternative.

Some specific products are cheaper on Amazon. Well that may be true but G4M are growing the business at a rapid rate regardless.

So for me it’s all about whether or not the growth will be profitable in the longer term to support the share price. I think we need to wait for the next set of results to get visibility on that. So I will continue to hold a small amount.

Rusty2

Swings and roundabouts, some items on Amazon when I have checked have been much more expensive, I'm not talking just about audio gear. You can't get everything cheaper from the same place I have found you have to shop around. Their delivery service is not very good, if you have the free option it can take along time to arrive and you don't when it will turn or not. Last item I ordered never arrived, had to get them to resend it, so it took about 3 weeks. Time before that they sent the wrong product. I have used G4M once and the service was very good and it was no more expensive than anywhere else. I misunderstood G4M as first, thought it was just another low margin pro audio store but it seems much of their sales are from instruments, there is a large EU competitor Thomanns but seems to be a slightly different market, G4M sales are growing rapidly in Europe so they must be doing something to attract customers. Amazon are not so popular in some countries. Anyway I'm not a holder at the moment I sold out a few weeks ago.

Nick Ray

The guitar that Matylda found "on Amazon" was actually in the Amazon Marketplace. It was not sold by or fulfilled by Amazon, but a tiny company based in Wembley. Every other vendor selling the same guitar on Amazon was charging about the same as G4M.

If the tiny company can undercut the rest by 10% good luck to them but I don't think they represent much of a threat to G4M's revenues just yet.

Vsihv

Thanks Graham - great analysis and very helpful.
Thanks for posting the link and the analysis (today and from December) and all other days - much appreciated

gus 1065

As a user of and shareholder in £G4M I think they have the potential to grow into a role as Wiggle is to cycling for musical instruments/consumables, i.e. a trusted specialist “go to” vendor with a catholic mix of decent quality own brand product together with specialist names at competitive if not necessarily the best price matched to a reliable and timely delivery service.

Having shopped around for cycling gear over the years I’ve tried other online vendors with varying levels of satisfaction and now rarely bother shopping around. Nowadays, if I want/need something online (I still use my local bike shop for specialist service or kit) I use Wiggle in the knowledge that they value their brand name and are unlikely to get greedy on margins for short term gain. Amazon is great for a lot of “commodity” stuff where price is sine qua non but I think that music and bike supplies offer space for a quality specialist. I think G4M have the opportunity to grow into this role.

Gus.

LeoInvestorUK

I don't hold £G4M because I see them as a musical AO World (LON:AO.) - an overpriced niche online retailer than makes low margins and ultimately fails to compete with Amazon. The comparison with Wiggle is a very good one - they are in a very similar situation as evidenced by two consecutive years of losses in a mature market: https://www.retail-week.com/sectors/sports-and-leisure/wiggle-losses-widen-despite-climbing-sales/7026367.article?authent=1

What I hadn't realised until today was just how expensive G4M are and how bad their cashflow is. I tried to short them today, but no stock was available.

Musical equipment is clearly a growth area though and I do hold Focusrite (LON:TUNE) because they are much cheaper (though not cheap), are growing too, have good quality characteristics (margin, cashflow) and, perhaps most importantly, actually do something that adds value.

AnonymousUser192020

Interestingly, Gus, the analogy of £G4M to cycling suppliers had also struck me. I suspect musicians are similar to cyclists in making occasional big purchases (eg new bike or wheelset every 2-3 years) but spend a somewhat smaller annual amount on many components, consumables, upgrades. I respect your loyalty to Wiggle but to be honest I haven't used them for many months. I've found Merlin, Chain Reaction, Ribble, Tredz, Planet X etc etc all to be highly reliable and often a few % cheaper for most components especially around sale season. I think most in my club 'shop around', perhaps not as avidly as me. Evidently the far larger (?) cycling market can support several online distributors with strong competition and, presumably, low margins.

So one of my concerns over £G4M is whether they can corner a large proportion of the market in their various sales territories or whether competition will emerge to eat into their sales and margins. If there is competition they will need to develop a strong USP to maintain brand loyalty, perhaps in the way that Focusrite (LON:TUNE) seems to have achieved in digital music devices, albeit a more pro-oriented market. Or it may be that the market is sufficiently niche that other online specialists don't consider it worth attacking, seeing a bigger cake elsewhere. Another example might be the recently-floating fishing tackle chain (sorry, forgotten its name) thought that struck me as a weaker proposition as barriers to entry appear even lower. It will be interesting to see how this plays out.

mojomogoz

Hi muckshifter

I am interested in your comments on Keller (LON:KLR). Partly as the damage in contractors took me to Babcock International (LON:BAB) just as it got kicked out of the FT100. Different business focus of course but the same sh1tty stick seems to be tarring them in that investors are spooked around accounting for these long and/or sometimes complex contracts and/or joint projects.

Anyway, all I've done is look at the Stocko info on Keller (LON:KLR) at the moment (inc the accounts) and I see relatively significant debt issuance in last few years and negative FCF due to high capital investment. Does this relate to contracts in that they then need to provide the finance up front and then get paid at the back end or is something else going on?

Thank you

millen: Wiggle bought out Chain Reaction Cycles and operate it as a second brand. I agree with you that the other independents are generally cheaper than Wiggle and just as good.

I'm sure Paul Scott won't agree about G4M being like AO World (LON:AO.) Looking on Trustpilot, G4M get 5 stars, Amazon only get 2 stars. I think a lot of pros will be inclined to use a specialist retailer rather than Amazon. A lot of Focusrite (LON:TUNE) products are sold by G4M.

Hi millen.

Thanks for your comments on the cycling/music parallel. I’ve used Chain Reaction and Ribble in the past with varying results - mostly pretty good. I should probably revisit in light of your comments.

One further thought on Wiggle is the decent loyalty scheme depending on cumulative historic spend. I think it’s something in the order of 12% for Platinum members which makes them (for me at least) very price competitive. Coupled with my general satisfaction with their dhb own brand kit (fine for day to day use), I’ve probably become their ideal “inert” repeat customer. I wonder if £G4M have/will have a similar feature.

FYI, I think the fishing tackle company you had in mind might be Fishing Republic (LON:FISH) . Similar “disruptive” model but issues with large levels of inventory/very slow stock turnover as I recall.

Gus.

DJCP

For information, G4M have some (nearly 1,400) items listed on Amazon.co.uk
https://www.amazon.co.uk/s/ref=nb_sb_noss?url=search-alias%3Daps&field-keywords=Gear4music&ajr=2

Thanks Gus and leoleo. I wasn't aware of Wiggle's loyalty scheme - I'll look into it. Tredz sends me occasional £10 vouchers and there were other discounts around Xmas. Just for fun I looked at Wiggle's accounts https://beta.companieshouse.gov.uk/company/02667809/filing-history I'm wary of reading too much into a private company's filed accounts but it's interesting to see they reported a small loss of -£4m on turnover of £205m, half of which was outside UK. So sales are 3x that of £G4M currently. I think this is after the CRC acquisition. Bridgepoint are a major investor so maybe they'll float one day.

My only real experience of (much smaller) niche on-line distributors was when my cousin set up a model aircraft distributor. Even though he had good distribution deals with premium brand manufacturers, got good traction with the magazine reviewers, and had a gross margin of 50% on many lines, the range of stock that had to be held (spares etc) was ridiculous - much of it became technologically obsolete and had to be flogged on the eBay shop at lower than cost. The whole business was also undermined by customers buying direct from China, under-declaring for customs etc.

Building a successful on-line distribution business is not in any sense easy. The product area ('niche') has to be chosen wisely to offer sustainable margins without attracting competition, profitable distribution agreements negotiated, marketing and social media campaigns developed, infrastructure put in place etc. I have a small holding in £G4M but am surprised at the current high market rating.

Paul Scott

Hi,

I thought the update today from G4M was absolutely fine.

I agree that the valuation is high, but that's because the company is delivering stellar organic growth, across Europe, not just the UK. Plus it has global ambitions, so is developing websites, e.g. for the USA too. We've already seen that it is capable of operating successfully overseas, so it's really now just a roll-out globally. I think this will be a much, much bigger company in say 5-years' time, hence why the shares are attractive, even on this apparently high valuation.

As the company grows, then it achieves economies of scale, not just on purchasing, but also on the biggest overhead - marketing. We've seen with BooHoo how, once critical mass is achieved, then marketing spend becomes a smaller percentage of revenues. In the case of BooHoo, they have decided to recycle those gains into even more aggressive prices, thus driving continued strong growth. They could have instead accepted slower growth, and a higher profit margin.

G4M is also about backing a very entrepreneurial, focused, ambitious management team.

I think this share is fairly priced for now, so it might just flat-line for a while, who knows? It's not liquid enough to be able to move in & out quickly/easily, hence why personally I've banked some profits along the way in real life and in BMUS, and intend just running the balance for ever, or until the facts change for the worse.

With growth companies like this, conventional metrics such as PER and free cashflow are not terribly useful during the rapid growth phase. It's more a question of looking forwards say 5 years+, and seeing what the picture will be then, once margins have risen through economies of scale, etc.

So for me, this is a long-term tuck away and forget type of share, which I'm pretty confident about. For now though, the price looks up with events.

Regards, Paul.

Laughton

6th Jan '18

For those who are interested in £G4M, here's a bit more reading available -

http://walbrockresearch.com/will-lack-future-profit-harms-gear4music-share-price/

Personally I was a little disappointed in the slight slacking off in growth and have sold nearly half my holding. I think the market still has some way to go but I'm trying to be careful and "in-line" isn't really good enough, especially in supposedly "high growth" distruptors.

Orangetree

Thanks for promoting my blog Laughton!

VegPatch

8th Jan '18

Hi Orangetree - are you Walter Hin from Walbrock?

I like much of your blog. Its good (although I am way more bullish on Provident Financial).

keep up the good work

VegPatch

muckshifter

9th Jan '18

Sorry lavinit, just spotted your response, and thanks for that, as I have a habit of posting about unfashionable shares and getting no response at all.

I’ve always read the KLR finance director’s report avidly over the couple of years and a few before I invested. The statistics here on the stock report page are a bit too abbreviated for me in the case of a complicated company like KLR. The actual cashflow details have been interesting if a little dissapointing recently, with lots of aquisitions, opening up of new areas, etc. complicating things, as well as one poorly timed (imho) major buy in Canada. But the thing which I believe has impeded progress most in the last few years has been lack of recovery from the GFC in Europe, and the extreme slow down in investment in commodity based companies, notably the Canadian tar sands.

So, what has kept me in KLR for the last couple of years, apart from a decent dividend, is a patient expectation that both these slowdown causes will abate, and that appears to be happening now.
The “icing on the cake” to me is that the last chance Trump has to survive (imho) might be a massive infrastructure push, where he has a slight chance of cross party support from the Democrats. Badly damaged infrastructure might well give KLR fantastic repair opportunities or ground improvement work to provide a better lifespan for the replacement. But I’m not holding my breath on the US prospects as I do not expect Trump to survive as president. For the best part of a year now I’ve been banging on about the prospect of clause 25 of the US Constitution being invoked to remove him, so I see it as a race between that and Mueller.
Regards.

Thanks

Small Cap Value Report (Fri 5 Jan 2018) - G4M, CRAW

£G4M (Gear4Music)

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Graham Neary

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