City broker Peel Hunt has downgraded Gear4Music Holdings PLC (LON:G4M) to ‘Hold’ from ‘Buy’ and cut its target price in half citing warehouse issues and the re-emergence of pricing pressures for the instrument retailer.
“Sales growth is strong at G4M and the customer numbers and online metrics continue to progress. However, there have been problems at the warehouse (the Nov/Dec spikes were too much for it to cope with) and – more worryingly – the pricing pressures that we thought we’d seen the last of, have re-emerged, leaving gross margins needing a reset”.
READ: Gear4Music shares plunge amid 2019 profit warning as UK capacity constrains sales growth
Analysts also said that the company’s UK distribution centre had been “overrun with demand at peak times and management had to retarget its marketing to Europe to stem the tide”, which while being “great in some ways” had the broker worried as “management wasn’t able to implement Plan B to meet the demand”.
Another issue was the re-emergence of pricing pressures, with the broker saying that into Black Friday gross margins had “come under a lot of pressure”.
“The outcome in H2 in terms of gross margin decline (160 bps) won’t be as bad as in H1 (230 bps), but the absolute gross margin is now 350 bps lower than when the business was half the size in sales terms… There’s no doubt that management is pursuing the right policy in winning as much short-term market share as it can and not giving up its competitive position. The problem is that the irrational pricing behaviour is persisting longer than expected.”
As a result, analysts slashed their target price to 500p from 1,000p while cutting its pre-tax profit forecasts for 2019 by 69% to £0.8mln.
“It is difficult to see the shares coping terribly well with the downgrades, even if the policy of prioritising winning market share is well known, and it may take a couple of solid earnings prints to reassure investors that the margin picture has truly stabilised.”
The downgrade followed a profit warning issued on Friday morning when Gear4Music reported sales growth over the four months to 31 December but added that capacity constraints meant underlying earnings (EBITDA) for 2019 were now expected to be “slightly below” 2018 levels.
Gear4Music shares were down 44.6% at 282.5p.