String Fever

Editor's note: This article was updated on July 13.

Vince Romanelli is a 24-year-old musician who plays guitar, drums and keyboard and works with Autumn Records, in Nashville. Wayland Patton, 48, is a musician and composer who has co-written hits such as "Turn It On, Turn It Up, Turn Me Loose" for country crooner Dwight Yoakam. Patton also runs the guitar department of the cavernous Guitar Center store in Nashville.

Guys like Romanelli connecting with guys like Patton is the reason that Guitar Center Inc. earnings are climbing quicker than a Jimi Hendrix riff and why its stock has nearly tripled in the past five years. That run looks far from topping out.

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Changing attitudes

Guitar sales are climbing the charts. Music Trades, an industry publication, says a record 3.3 million acoustic and electric guitars worth a total of $1.2 billion were sold in the U.S. last year. One reason for the boom: changing attitudes toward rock-and-roll. Rock is no longer seen as the music of "hippies, freaks and drug addicts," says Jack Sonni, Guitar Center's marketing chief.

Guitar Center sells aggressively to professional and aspiring musicians through radio stations, mailings and music contests. The Westlake Village, Cal., company stocks stores with a wide variety of gear - it's the nation's leading retailer of guitars, amplifiers, drums, keyboards and professional audio and recording equipment -- and hires salespeople who are usually musicians themselves. "You get gear lust just wandering around the store," says Romanelli. Sonni, who played guitar for Dire Straits in the 1980s, says that pros and aspiring pros account for two-thirds of sales, which should hit $2.1 billion this year.

Expansion should fuel future growth. The company expects the number of Guitar Center stores to grow from 170 to 420 within five years. The stores account for about three-fourths of sales. The company is also trying to apply its formula for success to its Music Arts subsidiary, a less-profitable chain of 81 stores that sells and rents band and orchestra instruments. That unit should grow to 400 stores, Guitar Center says. And because rock is an international language, the company has begun exploring overseas expansion. While annual sales of music gear in the U.S. total about $7 billion, sales in Western Europe, Great Britain and Asia combined are $9 billion.

Hendrix factor

Guitar Center stores tend to be more profitable than mom-and-pop music stores because the company has more efficient distribution and uses its rock-star status in the industry to cut deals with manufacturers. For example, it nabbed half of the 300 Hendrix-replica Flying V guitars made by Gibson and sold them for $8,000 each earlier this year.

Yet Guitar Center's stock (symbol GTRC) is hardly off the charts. At $41 in mid July, it traded at 14 times estimated 2006 earnings of $2.91 per share, according to Thomson First Call. The stock is down from the mid $60s a year ago because of a variety of concerns, including low profitability from the Music Arts subsidiary, weakness in online sales and a restraint-of-trade lawsuit.

But the core business remains strong, and analysts see profits rising 18% next year. Because of the company's position as a "category killer," Stephens Inc. analyst Rick Nelson expects the price-earnings ratio to expand and thinks the stock can reach $71 over the next year. That's sweet music to investors.