Gear4music is clearly in a far better position than at the start of the current calendar year. Interim results indicate that ahead of peak trading G4M is not only enjoying volume growth, but is also better placed to execute. Focus in H2 will be on margin restoration at some expense of sales. We adjust numbers accordingly. In our view, investors should focus on profit growth rather than sales. Moreover, we note the company’s arguably undemanding valuation.
Brisk 16% sales growth, a 250 basis points rise in gross margins to 25.2% and an increase in EBITDA from £0.7 to £2.0m were the salient features of Gear4music’s interim results statement. EPS improved to a 0.7p per share loss from -1.8p a year earlier. Data on sales and gross margin was previously released in the company’s 22nd October pre-close FY2020 H1 trading statement.
G4M expects full year financials to meet company expectations, but with a significant bias in favour of margin rather than immediate sales growth. The company reemphasised EBITDA margin recovery as a key driver of this improved performance in its trading statement. This was achieved with a combination of warehousing facilities operating more efficiently, a higher portion of sales being generated by own label, and overall economies of scale associated with higher revenues.
Looking ahead to Christmas trading, the company appears in good shape in terms of both its offering and logistics. That said, the company is unwilling to chase market share at the expense of margin in the very competitive UK market. As a result, we reduce our FY2020 full year sales forecast from £137.8m to £121.5m. However, largely due to the implementation of IFRS 16 which has no cash impact, our EBITDA profit expectations are lifted from £4.2m to £5.7m in FY2020 with another bump up from £6.5m to £8.0m in FY2021.
Operational disruptions appear to be behind the company, which is now reporting consistently better newsflow and is well set to grow. As a result, we argue investors should note what appears to be an undemanding valuation. The current EV/sales ratio is just 0.5x, which we think should expand as profitability rises. To us, 0.7x marks a sensible next step that, based on our revised estimates, implies a 350p share price.