Rule #1 Finance Blog

With Investor 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

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