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Guitar Center Growth Could Hit a Sour Note; Neuberger Overvalued

Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate merits of individual stocks.

February 13, 2001|JAMES PELTZ and MICHAEL HILTZIK

Guitar Center (GTRC) Jim: Don't Buy

Mike: Don't Buy

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Jim: I'd figure Guitar Center can tap into an endless demand for its musical instruments, Mike, because each generation brings us a wave of teenagers who want to be the next Eddie Van Halen--or maybe now it's the lead guitarist for Blink-182.

Mike: Really? I'm hoping my kids want to be the next Chet Baker or Stan Getz.

Jim: Naturally. Anyway, Guitar Center is the nation's largest retailer of guitars. It also sells amplifiers, keyboards, drums and electronic audio equipment.

Mike: But if you want a sax, clarinet, trumpet or violin, you'll have to go elsewhere.

Jim: Hence the chain's name.

Mike: Right. That's one of the issues I have with this company. But you can go on.

Jim: Gee, thanks for holding back your issues momentarily. I was just going to note that this company was founded in Hollywood in 1964 . . .

Mike: And then, like a lot of former Hollywood residents, it moved on up to Agoura Hills, where it's now headquartered.

Jim: Guitar Center has nearly 80 stores nationwide. In 1999 it made a big expansion move by acquiring Musician's Friend, a leading provider of musical instruments via catalogs and the Internet. Now, what are your issues?

Mike: To start with, everything I've read tells me that consumer purchases of musical instruments are increasing about 7% a year. So, let's take that as the cap on Guitar Center's top-line growth.

In fact, that was the percentage rise in the company's same-store sales last year--that is, stores open at least one year.

Even if Guitar Center gets the lion's share of that industry growth, I'd argue it's still pretty modest. This chain also pitches itself as the Home Depot of music stores and, like Home Depot, when Guitar Center opens a store in a new area, mom-and-pop competitors get hit hard. Guitar Center's nearest rival, Sam Ash Music, a private company, might suffer a bit but seems to be hanging on.

Jim: Where are you going with this?

Mike: I wonder how Guitar Center will be able to keep opening enough stores to accelerate its sales and earnings growth, given the expected modest expansion in consumer spending on guitars and other instruments.

Jim: Indeed, Guitar Center took a hit about 18 months ago when, among other things, its same-store sales growth slowed measurably.

Mike: One reason was that the company would move into an area, then move again into the same area.

In other words, it would open so many new locations that it would cannibalize sales at its old locations. This is, of course, the familiar quandary of retail expansion.

Jim: I would argue that Guitar Center faces more potential roadblocks in the general slowdown in the economy and the drop in consumer confidence. That is expected to put a lid on consumers' discretionary spending.

Mike: You can debate the degree to which a musical instrument is a discretionary purchase. In my house, the first musical instrument is not a discretionary purchase. Though for most people the fourth or fifth guitar would be.

Jim: There's another wrinkle here. For reasons I can't figure out, a year or so ago Guitar Center stopped selling the well-known Gibson guitar brand.

Mike: At the time of the split, both sides said it was perfectly amicable. That's the same thing I've been reading about the Tom Cruise-Nicole Kidman split.

Jim: The point is, there's a very popular guitar brand that Guitar Center isn't carrying in its retail stores, though its Musician's Friend unit carries it.

Mike: Right, Guitar Center is a place to go for all your guitar needs, as long as they're not Gibsons.

Jim: All of this knocked the stock for a loop in '99 and early 2000, then it mostly treaded water the rest of last year. Lately, though, the stock has resurged, and Monday it closed at a 52-week high of $18.25.

The company signaled in early January that its fourth-quarter sales were stronger than expected. On Monday, the chain said fourth-quarter operating earnings per share jumped nearly 29% to 45 cents a share, from 35 cents a year earlier. Total sales rose 25% to $240 million.

But I still wonder how much more profit growth this chain can squeeze out of its operations if sales turn so-so this year.

Mike: I agree.

Jim: So I'd avoid the stock, even though it's pretty cheaply priced at about 15 times analysts' average estimate of earnings per share for 2001.

Mike: Me, too. I have real questions about how strong earnings will be going forward.

Neuberger Berman (NEU)

Jim: Don't Buy

Mike: Don't Buy

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Mike: The party line on Neuberger Berman, a money management and mutual fund operator, is that it has always been known for contrarian investing. And, wouldn't you know it, its own stock has been a great contrarian pick for the last year--meaning it has soared even as shares of some rival firms have slumped.

Jim: That shouldn't surprise you, if you think about it.

Mike: Maybe I haven't thought about it much.

Jim: I'll explain, but first let's note that Neuberger Berman has long catered to the wealthy and . . .

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