Gear4music’s extraordinary European sales boost following the Brexit vote risks masking the strong underlying development of its business. We see this continuing to deliver strong double-digit revenue growth, independent of likely weakening in the UK demand environment, and led by its strategic focus on European market share. The company plans to invest in expanding the management team and establishing distribution bases in Europe, strengthening its profile for the medium term. We are raising our forecasts and our updated valuation offers upside against the share price.
Sales growth from strong to very strong
First half revenue growth of 73% showed marked acceleration from the same period a year ago (43%), with growth of 87% in the two months after the Brexit vote. Underlying KPIs were correspondingly strong, with website visitors up 27% to 5.6 million and the key conversion rate up from 1.79% to 2.38% y-o-y. Revenue growth was led by mainland Europe, where it accelerated from 137% y-o-y in the first four months to 239% in the last two. We expect international sales to continue growing relatively fast, reaching close to 50% of sales within our forecast period. This increasing exposure to the international market should help protect Gear4music (G4M) from any demand weakening in the UK in the medium term.
Significant estimate upgrade for current year
We are raising our FY17 and FY18 revenue growth forecasts to 58% and 41% respectively on the basis of the strength of growth, both in the UK and in Europe. Our forecasts take into account pre-vote growth rates, anticipating that the recent higher European sales growth following the vote will be temporary, even though the company reports continuing momentum heading into the pre-Christmas period. We are upgrading our FY17 PBT forecast by 21% to £2.0m and our EPS forecast by 18% to 7.7p. As a result, we forecast earnings growth of 146%. For FY18, we forecast 45% growth in PBT and 48% in EPS, after allowing for the full-year costs of European hubs and a step cost of expanding middle management.
Valuation: Estimates upgrade reflected in valuation
All our metrics indicate upside to the current share price. We continue to use a peer multiple comparison and DCF to derive an indicative value for G4M. Based on our upgraded forecasts and a slight reduction in cost of capital, our updated DCF value is now 392p. Our updated peer comparison suggests 332p. Finally, we introduce a growth-adjusted (PEG) comparison method, which indicates a potential value of 382p. The average of all three results in a blended valuation of 369p.