Guitar Center, Inc: Financial Ratio Analysis Report

Guitar Center is a retail chain that specializes in guitars, amplifiers, percussion instruments, keyboards, audio and recording equipment. There are currently 138 Guitar Center stores while the company also includes 19 family music stores that specialize in orchestra and band instruments. The company also owns Musician’s Friend, a retail operation filling catalog and website orders.

Guitar Center Inc. was incorporated in 1964 and re-incorporated in 1996. As of the year-end average, the organization employees about 6,500 people in several major markets and secondary markets. Guitar Center Inc. recently completed the acquisition of Music & Arts Center, a transaction with the purchase price of $90,000,000, which ranks as the highest valued acquisition the company has completed. In 2004, the company saw a gross profit of $425,274,000 and has seen a considerable increase with each passing year.

On April 28, 2005 Guitar Center Inc. announced their 2005 first quarter results with a comment from the Chief Financial Officer of Guitar Center, Bruce Ross, “We are pleased with our overall performance during the first quarter of 2005. While we posted an increase in consolidated net sales and Guitar Center comparable store sales in line with our expectations, we were able to capitalize on our efficient cost structure to deliver a 35% expansion in net income. It is important to note that recent sales patterns have been uneven, making it more difficult to forecast business trends, and our direct response division is also facing a higher level of online competition. Due to these current trends we plan to increase our advertising and promotional activities in the remainder of the year to drive store and online traffic. We continue to see strength within our industry as a whole, and we remain confident in our ability to maintain consolidated operating leverage and long-term profitability.” (Business Wire, 2005)

The growing technology involved with recording and receiving music is having an impact on all music related entities. The future growth of technology could continue to benefit Guitar Center, Inc. In Market Wire, they explain that music downloading is flourishing as well as, “The traditional music industry is flourishing as well. Guitar Center, Inc. (NASDAQ: GTRC), the nation’s leading retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment, recently reported that it continues to expect third-quarter earnings to be in the range of 39 cents to 42 cents per share, on sales of $342 million to $352 million. Just as Apple was due for competition, Guitar Center’s national chain is about to experience some of the challenges of free market capitalism. ICrystal, Inc. (OTC BB: ICRI) recently announced that it intends to acquire Fat Katz Music, LLC, a guitar and music retailer based in Baton Rouge, LA. Fat Katz Music currently operates one retail location, with a second location to be opened in the near future. ICrystal management sees the potential in capturing a portion of the market share that Guitar Center commands in the expansive music retail business. The music industry landscape has encountered some extensive reshaping in the last few years. This has taken place in the transition from traditional environments to that of digital and the online realm. Serious investors should consider these industry players in the emerging music industry. “(2004)

The following is a breakdown of the ratios that weigh heavily in the operations for Guitar Center, Inc.

Profitability Ratios 12/31/2004 12/31/2003 12/31/2002 Return on Equity (%) 20.68 17.21 16.3 Return on Investment (%) 11.04 8
5.58
Gross Margin 0.028 0.027 0.026 Operating Margin (%) 7.12 5.65
4.89
Net Profit Margin (%) 4.19 2.89 2.29 Liquidity Indicators Working Capital/Total Assets 0.47 0.43 0.24 Debt Management Current Liabilities/Equity 0.51 0.64 1.43 Total Debt to Equity 0.33 0.47 0.43 Long Term Debt to Assets 0.17 0.22 0.15 Asset Management Revenues/Total Assets 2.63 2.77 2.43 Revenues/Working Capital 5.61 6.42 9.93

These ratios that were included have the greatest impact on the day to day operations of this organization and provide an interesting look at the health of the company over time. It appears that Guitar Center, Inc. has done well in that ratios have been moving in the right direction over the past few years. Items like Return on Equity and Return on Investment have shown good growth while Current Liabilities/Equity has continued to shrink.

Guitar Center, Inc. is in a position where they are providing a product that is very specialized, since they are classified as an electronic store there numbers are weighed against industry giants like Intel and Apple who operate in computers and high tech equipment. The musical instrument market has carved its own niche into the industry. The result has been that Guitar Center is in competition with small “mom and pop” shops that operate in neighborhoods.

In terms of the industry Guitar Center, Inc. is involved with, they are blown away in terms of ratios. Intel alone calculates ratios at 19.58 for Return on Equity, 21.97 for Net Profit Margin, but factors such as Debt Management and Asset Management provide similar ratio calculations. This demonstrates how Guitar Center, Inc. is operating as well as large industry leaders like Intel, but is just not operating at the same size.

It is easy to look at Guitar Center Inc.’s Net Profit Margin ratio and see that the company has been able to make positive decisions that have helped to push profits forward with each passing year. That they have been able to go out and acquire most of their competition shows increasing strength within the market. The company has been able to ease away from high debt to equity ratios and the gross margin has been able to stay steady over time.

The financial condition of Guitar Center Inc. is strong and improving with every passing fiscal year. The organization has been and will continue to be aggressive in opening new stores and have brought strong marketing campaigns in order to get the word out that Guitar Center is the place to go for musicians. By staying geared towards musicians, by employing musicians and knowledgeable sales staff, Guitar Center is able to develop strong relationships and customers will continue to come back to the wide variety and reasonable prices that the stores are able to allow.

My assessment is in line with that of the management as the goals and methods of the company are clearly visible. In the 2003 annual report, the management of Guitar Center, Inc. clearly state, “Our expansion strategy is to continue to increase our market share in existing markets and to penetrate strategically selected new markets. We believe there exists a number of acquisition opportunities in the relatively fragmented band instruments market that could be a good fit into our American Music platform and continue to pursue acquisition opportunities. We also believe there may be attractive opportunities to expand by selectively acquiring existing music products retailers or other complementary businesses, if attractive opportunities can be identified.”

The positive growth in cash flow seen since 2002 is a great benefit for the company in its attempts to branch out and to develop a solid name brand. Guitar Center, Inc. is in the type of position that many other electronics and entertainment companies are in. The public’s taste at any one period of time could have a great effect on the success of the company. By providing musical instruments the company owes a debt to musicians already creating music. Just like a new toy can lead to rushing mobs at toy stores, released music and specific musicians that might catch on with a wide range of people can really fuel the sales of instruments. This is unfortunately something that Guitar Center can not plan for. The recent surge in popularity of musical groups primarily using guitars is sure to have helped the positive numbers that Guitar Center, Inc. has enjoyed the past few years.

Guitar Center, Inc. needs to maintain focus on what markets they decide to open stores in and pay attention to the culture and schools that surround the possible new location. Schools with healthy music programs could provide consistent business, but in most cases school programs have close relationships with prior existing instrument stores. It is also very important for Guitar Center, Inc. to be in tuned with the musical culture of where it opens new stores.

As the company continues to grow and acquire new entities and build new stores they absolutely have to stay on top of providing an image that is exciting and catered to musicians. Guitar players can be a finicky bunch that moves from one trend to another, Guitar Center, Inc. has to stay at the cutting edge of those trends while also providing a classic image for the older musicians. It is a difficult balancing act and not much different than the act done by successful musicians. So far they have done a commendable job and future success should be counted on.

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