Phil Town
Phil Town

Here's a Guitar Center followup from Jonathan:

OK Phil Town

Here's a little more on guitar center.  When I dug into the cash flow I found where in 05 they spend 74 million from cash on additional inventory for the new stores.  Is it good for them to spend the cash on that, or should they be getting that money from somewhere else? 

Anyway, when I added the capital expenditures back into the cash flow numbers things got a lot better.  So much so that I question doing this right. 

They also talk in the reports and conference calls that I listened to that the cash flow in general has been up and down due to aggressive expansion.  And they want to expand even more than ever before in 06, so I would guess that the cash flow numbers are going to continue to be all over the place. 

They also addressed, in a conference call, that 2nd quarter investments hurt the 2nd quarter numbers, but that the return on those investments would show up and help the 3rd and 4th quarter numbers.  That seems to me like the reason the stock price is low right now.  Everyone is waiting to see if those investments really do help the numbers later this year.  I also found this that may explain why the CEO is not as candid as we would like:

NEW YORK, June 21 (Reuters) - Investors' single-minded fixation on whether companies meet Wall Street's earnings forecasts is a "broken model" that gags them from talking about their business outlook, Guitar Center Inc.'s (GTRC, Trade) chief executive said on Wednesday.

"I think it is the most fictitious and difficult obstacle in the relationship between you as a business and your investment partners," Marty Albertson, who is also chairman of the musical instruments retailer, said at the Reuters Consumer and Retail Summit in New York.

Publicly traded companies like Guitar Center are expected to give analysts a long-range forecast for their earnings and sales. But companies find themselves in a bind when market conditions change since anything they say could force analysts to adjust their models.

Any swing in Wall Street's numbers can send a stock tumbling or soaring.

"It makes investing more like Las Vegas," Albertson said. "If the world could figure out a way to get by without that consensus number, then you wouldn't be restricted as a business leader in talking about current trends. Companies would like to treat their shareholders as partners, he added, "but you have to hold them at bay."

He said the most successful investors ignore consensus earnings-per-share figures to focus instead on a company's management team and its long-term success.

I did notice in the letters to the shareholders that each year they address the previous year's issues and tell what happened in those areas.  But they don't talk about them as "problems".  They just say, "here is something we are going to work on".  Then once I read the next year's letters and looked at the financial statements I realized they are going to work on them because they are issues.  So I know that they know what needs to improve.

So, all in all, I like the business.  I think they are doing the right things.  In the conference calls I listened to they talk a lot about adapting to the cultural trends as one of the most important growth factors for them.  That's very smart.  They have to be selling the instruments that the kids see on tv today, not 5 years ago. 

They are going after the school band market which is very diversified now.  Most companies that deal with school band inst only deal with those inst. not keyboards and guitars and recording equipment also, so guitar center is trying to get them as a customer from the very beginning of their musical lives.  And be the only store they ever need from then on.  They have just fully launched the online store and the integration they are planning with that will be one of kind in this industry and on the cutting edge of what I think will be a very popular feature in all retail stores eventually.

Well, that all being said, the stochastic indicated a buy trigger today [July 11], so I am going to wait for the other two and start with this one.  Unless there is something obviously wrong that I am missing??

Talk to you soon,

Jonathan Parker

Here's my critique of Jonathan's homework:

Nice work, Jonathan.  You are definitely doing your homework.  The key to being happy with Guitar Center lies in getting really comfortable with the long term prospects for the business.  Can you get an idea of what would happen to the business if there was a serious economic downturn?

One of the reasons the stock is down is, as you say, the market watching to see if the earnings do kick in.  That gives us a great opportunity to buy this business at a big discount. 

But another reason the stock is down has to do with the fear that the consumer is running out of money to consume with -- which means that retail in general may be hurt.  For that reason we see businesses like Chico's and Coldwater Creek on sale, too.  And to some degree that logic is hurting the stock price at Whole Foods.

Let's take Whole Foods as an example of what I mean by getting comfortable with the long run regardless of what happens.  I think Whole Foods represents a successful paradigm shift for a very large numbers of grocery consumers.  That means that even with a downturn in the economy, I think consumers will continue to go to Whole Foods in spite of the higher price because of the higher quality of food, the atmosphere and the store layout.  I don't think we're going to go back to Albertsons even if there is a recession.  And the last people hurt by a recession are going to be Whole Foods shoppers.

Talk to me about Guitar Center.  What happens in the music instrument business when retail in general starts to slow down.  Do people put off buying that guitar?  Or do they buy it anyway?

Time to look out into the murky future and determine if Guitar Center is one of those businesses that can ride through a recession and inflation and come out smelling like a rose.

And it's also a great reason why we use tools: so that we can buy companies like Guitar Center and if they start to get dumped by the big guys, we just get out and wait for the crash -- then buy back in at recession prices.  Now THAT is where we can make some serious bank.

Now go play.

Phil Town