Shares in online musical instruments retailer Gear4music (G4M:AIM) rallied 6.2% (12.5p) to 215p as the shunning of less profitable sales and focus on selling higher-margin products drove a material improvement in first half gross margins.

In today’s trading update for the half year to 30 September, York-based Gear4music also sounded upbeat ahead of the pivotal Christmas period and confidence in full year forecasts and the recovery story has increased accordingly.

FINE TUNING THE MARGIN STRUCTURE

Last year Gear4music, a purveyor of own-brand instruments and premium third-party brands such as Fender, Yamaha and Roland, reported high levels of top line growth.

Unfortunately, this came at the expense of gross margin as the company was forced to reduce prices in response to competitor discounts. Profit warnings and earnings downgrades ensued and shares in this once popular retail investor story slumped from a peak of 865p reached two years ago.

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More recently, management has pressed ahead with a strategy to rebuild profitability, one which evidently paid off during the first half. Investors liked the sound of a 29% surge in gross profit to £12.4m as gross margin improved by 250 basis points to 25.2%, comfortably ahead of the 80 basis point margin uplift N+1 Singer was looking for.

Gear4music’s total sales ticked 16% higher to £49.4m. Admittedly, UK sales growth slowed against tough prior year comparatives, up a modest 3% to £24.8m in the period, but European and Rest of the World revenues rose by an impressive 33% to £24.6m, demonstrating the international growth potential of the business.

SOUNDING A POSITIVE NOTE

‘We have restored our gross margins to full year 2018 levels whilst at the same time continuing to grow our revenues and taking market share,’ enthused chief executive officer Andrew Wass. ‘International sales growth continues to be strong, and whilst the UK market remains highly competitive, we have returned to a more profitable margin structure and believe that this is the right strategy from which to grow our revenues going forward.’

There was also investor relief as Wass assured that the retailer remains on track to hit its full year earnings before interest, taxation, depreciation and amortisation (EBITDA) targets heading into the key Christmas period.

Panmure Gordon is sticking with its ‘buy’ recommendation on Gear4music, forecasting a pre-tax profit rebound from £600,000 to £2.3m for the year to March 2020, rising to £4.5m and £6.6m in 2021 and 2022 respectively.

‘After revising down our earnings forecasts twice during the last financial year, there is an added importance to meeting expectations for 2020 and restoring investor confidence,’ wrote the broker. ‘The second half historically has represented (greater than) 60% of annual revenue and Christmas will again be key to the full year outcome. Whilst the slowdown in UK expansion may disappoint some investors, we support management’s focus on rebuilding margins.’

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Issue Date: 22 Oct 2019