Gear4music (G4M) is marching to the beat of the online opportunity in the niche area of musical instrument retailing. Traditional competition is fragmented and only partially online, so the market is wide open. With sales growth of 46% in FY16, G4M now has 3.5% of the UK market, and is focusing on the European market, which is six times larger. We think the company has scope for significant revenue growth and, assuming undemanding economies of scale at operating margin level, we value the shares at 186p based on peer comparison and DCF modelling.
G4M is a disruptive online retailer selling tangible product in a specialist interest space. Management is focused on realising its substantial opportunity. The musical instrument market is fragmented, and online competition is limited. With 10 million unique visitors in FY16 and a 34% jump in active users, G4M continues to invest in its platform of 19 international websites, customer marketing and service capabilities, together representing a growing competitive lead and barrier to entry.
Maiden prelims show the first year growth that was expected at the June 2015 IPO being realised. G4M is seeing the benefits of competitive pricing and best-in-class service and delivery, with 57% H2 sales growth in third-party brand sales, which form three-quarters of its business. Its own brands are developing well with 35% H2 growth, and European penetration is rapidly expanding with sales up 79% in H2.
In the light of G4M’s progress to date and the European market opportunity, we initiate with an FY17 growth forecast of 165% in PBT and 108% in EPS, and FY18e growth of 66% in both. Yet these are driven by undemanding assumptions of sales growth flattening from 46% to 24% over the next two years (of which, at least in Q1, there is no sign) and by a modest rise in EBITDA margin from 4.8% to 6.4%.
At a calendar 2017e P/E of 13.0x and EV/EBITDA of 6.5x, G4M shows discounts of 22% and 15% respectively to online retail peers, after adjusting for relative size and liquidity. On this basis, the peer valuation is 160p. Our DCF valuation is 212p, within a forecast scenario range of 119-299p. Averaging these two metrics indicates a valuation of 186p, equivalent to a CY17 P/E of 18.4x and EV/EBITDA of 9.5x.