Don't fall into HMV 'value trap', investors warned

Is HMV (HMV.L) an underdog or just a dog?

Broker Seymour Pierce believes the struggling retailer is a ‘value trap’; that despite the 73% tumble in its share price in the year-to-date, it is still expensive relative to its intrinsic value.

In a research note published today, the broker downgraded its earnings forecasts for HMV in 2012, following last week’s results – in which the music and DVD retailer posted a 61% drop in annual profit – and the disposal of its Waterstone's books chain and its Canadian arm.

‘The restructuring so far has failed to create shareholder value and does not address the structural pressures the core business is under,’ the broker wrote.

Reiterating a ‘sell’ recommendation, it added: ‘We continue to believe that the intrinsic value, if any, of HMV UK is in decline and we are sceptical that management’s strategy of turning HMV into an entertainment brand will work.’

In morning trading, HMV shares eased 0.04p, or 0.5%, to 8.82p – valuing the company at £37 million.

Source: Hindsight

The 90-year-old group last week reported a profit before tax and one-off items of £28.9 million in the 53 weeks to April 30, in the wake of four profit warnings this year.

The firm branded its performance ‘disappointing and unsatisfactory’. Yet, citing ‘decisive action’ to restructure the group, HMV said it had a clear strategy to become a broad-based entertainment business.

On the back of the disposals, HMV secured a two-year credit facility of £220 million with its banks to refinance its debts. Seymour Pierce said that in light of the move, the broker now expects HMV to post pre-tax profit of £2 million in 2012, and for profits to continue to fall in 2013.

‘We remain sceptical given the structural pressures in its core market place of physical music and gaming and do not believe that the move more aggressively into portable digital technology will be strong enough to drive footfall and earnings,’ the broker said.

It went on to say: ‘We continue to believe that the business is a value trap and management will struggle to grow profitability.’

As other investors have fled the stock, Andrew Brough’s Schroder Mid 250 fund has held onto its 25 million shares, according to data to mid-May, representing a 5.9% stake in HMV. The stock is not, however, one of the fund’s top holdings.

And Robin Hepworth has maintained a small holding in HMV in his Ecclesiastical Higher Income fund, a Citywire Selection pick. He told Citywire last month that its share price fall was an overreaction and offered ‘some value’.

Meanwhile, data from Starmine Professional show that most brokers take a dim view of the stock. There are currently three ‘hold’ recommendations for HMV; one ‘sell’; and four ‘strong sell’, with an average target price of 8.43p.