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

5th Jan '18 by Graham Neary

41 comments 15716 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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MrContrarian

5th Jan '18

My morning smallcap tweet:

Crawshaw (LON:CRAW), Deltex Medical (LON:DEMG), Redt Energy (LON:RED)

Crawshaws (CRAW) trading. 15w to 24 Dec: Rev up 0.6% but LFL -6%. They are merely standing still by opening factory shops. Blames consumer environment even though they are a value brand. 'Continued progress' against strategy as Britain's leading value butcher. If that's progress I'm a Luddite.
Deltex Medical Group (DEMG) warns FY rev £5.9m down 7% as £200k order delayed. Signs of "pipeline blockages" easing in Q4 2017. You don't want to know what image that puts in my mind. First revenues generated from three new potentially large accounts. Cutting costs.
RedT Energy (RED) exits legacy Camco business (clean energy project financing arranger).

browndogwork

HI Paul and Graham. If it's another quiet day on the RNS front, I would be interested on your views of Redt Energy (LON:RED). They released a statement about their African business this morning which they are now exiting to focus purely on energy storage. It's a fascinating company. Thanks!

Sgtem25

Your views on today's trading update by £G4M would be appreciated please!

GrahamF

We know Paul is keen on £G4M so it would be good to have your view Graham. My view is that the great top line growth will feed through into satisfactory profits given time and patience will be rewarded.

daveinthelakes

Edison just issued research update on £G4M-

http://www.edisoninvestmentresearch.com/research/report/gear4music-holdings183428/full

Vsihv

Since it is a quiet day so if you have the time, would value your expertise.
Do you have any thoughts on the spread betting/CFD names. Sector in the doldrums but had a rally since the Plus 500 trading update and there could be a read across to other names (CMC has best value me thinks), which have not had the same bounce as Plus500 (LON:PLUS). That said, from Plus500 trading update, I am not sure how sustainable the growth is and if many of the new customers in Q4 will leave if they get stopped out at say $10,000 or cryptocurrency equivalent? CMC on the other hand don't offer crypto so far as I am aware.
I appreciate it is somewhat of topic for the small cap value report - please spare me the thumbs down!

Graham Neary

Hi guys, thanks for the suggestions.

sharmvr: I covered IG Group (LON:IGG) and CMC Markets (LON:CMCX) last month, not sure if you've read that already but here is the link.

IG provide bitcoin and bitcoin cash. They are working on litecoin and will probably offer ripple soon too.

Steve - yes, I will cover Crawshaw (LON:CRAW).

Graham Ford - yes, I will cover £G4M.

Will have a think about £REDT.

Cheers

Mike Rawson

IG already offer Ripple. I bought some yesterday and have already been stopped out.

They also offer Ether, but Litecoin isn't there yet.

ricardow

Many thanks for your thoughts on £G4M. My view is that this company's concept is flawed for at least 2 reasons:
1. If you buy, say, a saxophone, you will probably keep that saxophone for several years before selling it in the 2nd hand market. So repeat business is going to be sporadic.
2. Most serious players of music want to try out an instrument before they buy it. They want to know how easy it is to play (a matter of personal "feel") and to listen to the quality of the sound it makes. It is not like buying a book from Amazon.
So it's not for me. Good luck if you disagree.
Richard

muckshifter

Any thoughts anyone on Keller (KLR) after today’s two announcements? They are in talks about a takeover with a relatively small east coast US specialist geotechnical type contractor who sound attractive and complementary, at the right time, to me, and they seperately gave a positive indication of the anticipated effects of new US tax laws on their income. A large portion of their work is in the US.

Keller are the first civil engineering company that I’ve bought into for about 15 years, after decades of making extremely good and occasionally exceptional profits on shareholding in the sector. I bought after they announced a major problem with a completed project a couple of years ago, which appeared to fit the pattern that had served me well in the past, based on a lifetime working in heavy civil engineering.

The thing which used to make this industry attractive to me was that companies would be hit badly by a bad contract or two, where they made big losses (for example, the toughest job that I ran in that era was losing more than 50% on turnover at 67% work done – but in the end we recovered and made a profit by the time contract issues were settled more than a year after completion). On contract completion, losses stopped, and as in my case above, very large cash payments were often received because of problems encountered which were not the contractors responsibility under the terms of the contract, ie. recovery, in the right circumstances could be dramatic provided the contractor could survive.

Laing were a turning point for me, and subsequent changes reinforced my wariness. I sold out of Laing, who were one of the UK’s most prestigious contractors @ £5.80 and predicted that they would have to give away their construction company – they actually in the end had to pay O’Rourke to take it – because they had undertaken several very large, unique jobs, on a very rare contract basis where they took on big risks which normally remained with the client. Similar contracts have recently decimated Interserve I believe. Subsequent significant changes occurred as a result of PFI, where many contractors became part “facility managers” – again I didn’t like this on the basis that if you get it wrong you might have 25 years of pain, without the ability to reverse the cashflow at the end ie. the pain might end but there would be no pot of gold.

Anyway, the point I’m making is that I see KLR as still working predominantly in the old mode, in a very specialised field, where they are the world's largest contractor, so I would welcome any opinions, positive or negative.
Regards.

Hi Mike - thanks for pointing that out re: IG Group (LON:IGG).

I was on their app yesterday checking out their crypto offering and didn't spot Ripple there. But you're right, they do have it on the system now.

Graham

I have used £G4M on a number of occasions.

The regularity of repeat visits might not be the same as an online clothing retailer (Boohoo, Asos) but I think Paul mentioned that the average value of a G4M order is far more.

Musicians tend to suffer from GAS (gear acquisition syndrome) so are always looking to buy new toys. It's not like a shop selling one-off items (eg. lawnmowers) - there is always a new gadget, guitar or amp on a musician's wish-list. Guitarists also tend to become collectors - I had about 7 in my peak playing days...there's nothing quite like a wall of guitars! (this view may be more specific to guitars/drums, which I imagine makes up the majority of G4M's sales)

Re: online presence, I agree to a certain extent and it all depends on how serious a musician you are. I would be happy buying anything but guitars without trying first, and even then, if it's a recognised brand I might make an exception. What's stopping people from trying out an instrument or amp in a local shop, then ordering online for cheaper? That's what people do with Amazon. Also, many learners or musicians who lack confidence hate going into a shop and having to try out a guitar in front of people, so buying online is ideal.

G4M's advantage is also the sheer volume of choice. I have a friend who owns a music shop locally and he just cannot compete with online prices and availability. Actually, he should hedge his risk by purchasing some G4M shares!

I don't own any G4M by the way, but have done in the past.

Hi Richard, you're welcome re £G4M. I do agree with you on those two points.

tjl

Anybody any idea why LON:IBPO shot up 20% this morning before falling back to +14% at time of writing?

simoan

My view is that this company's concept is flawed for at least 2 reasons:
1. If you buy, say, a saxophone, you will probably keep that saxophone for several years before selling it in the 2nd hand market. So repeat business is going to be sporadic.
2. Most serious players of music want to try out an instrument before they buy it. They want to know how easy it is to play (a matter of personal "feel") and to listen to the quality of the sound it makes. It is not like buying a book from Amazon.
So it's not for me. Good luck if you disagree.
Richard

Richard,

I honestly couldn't agree more! I wonder how many serious musicians would buy shares in G4M? As a guitarist, I find the idea of buying a guitar without playing it first totally absurd. Perhaps people just collect them for fun these days and don't care?

Once G4M have put all the small independent shops (where you can actually play an instrument for real) out of business by undercutting them on price, they will be screwed. I realise G4M has been a great investment for many and that this bias caused by my past love for going into small music shops to play around has cost me money.

All the best, Si

Ramridge

Hi Graham -
Re. £G4M A couple of points worth a mention are
Pretty thin operating margins (around 3.5% forecast for next few years) and negative forecast FCF due to capex. (All data from today's Edison Research report)
IMO this unhealthy combination jacks up the business risks considerably.
no position.

Pretty thin operating margins (around 3.5% forecast for next few years) and negative forecast FCF due to capex. (All data from today's Edison Research report)

This is the other kicker for me in the investment case. If you're going to buy something on a sky high rating why would you buy G4M over Fevertree Drinks (LON:FEVR) ? No competition in terms of quality.

fwyburd

RE: Crawshaw (LON:CRAW)

It's also frustrating when companies blame conditions beyond their control for poor results ("overall softer consumer sentiment"). The same companies are unlikely to attribute good results to conditions beyond their control.

There is some interesting research in this area from 2003 called "Mea Culpa".

The researchers analysed public announcements of bad news by listed companies. They found there was a correlation between better performance a year later when management took responsibility for the bad news, even when it was driven by external, uncontrollable factors.

This was because people tended to trust those companies more when they did so and less when they blamed those external factors.

Makes complete sense to me. And given that sustaining trust between management and shareholders is so important, I tend to avoid investing in those firms who blame others or external factors not themselves.

Francis

anothersaxman58

I've held off buying G4M because it always looks too expensive. But I think we may be wrong to focus on serious musicians. I suspect a lot of their business is impulse buys (maybe by chaps of a certain age who fancy a nice guitar or three to go with the sports car and expensive bike). And another large slice is the day to day purchase of cables, tuners, reeds and so on. Who knows?

Orangetree

Nice analysis Graham, my thoughts exactly.

The problem with G4M is theIR PER multiple, it's too high and like you said expectations are built in. But Paul's analysis is based on realising economies of scale in the future.

If we believe the Brokers' forecast that net profit is £3.7m by 2020, then I expect a "de-rating" to 20 times PER, because earnings growth is 20% per annum.

But, if it smashes earnings expectations, and assuming it did £10m by 2020, then the market could value the shares between £22.50 and £33.50 per share.

The differences between £3.7m and £10m are the differences between growing at 20% and 67% per year. With £10m the market could put a multiple between 45 to 65 times PER.

Depending on how much leverage G4M has over major manufacturers and sub-contractors will determine their future profitability.

Walbrock

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

£G4M (Gear4Music)

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Graham Neary

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