Firstly, I think investors are missing a trick with their valuation of Character Group (CCT: 485p), the fourth largest distributor of toys in the UK. The company has just reported a near 75 per cent hike in both full-year pre-tax profits to £12.2m and 48.5p, respectively, in the 12 months to end August 2015, an outcome well ahead of joint house broker Panmure Gordon’s £11m profit estimate, although I acknowledge that the strengthening US dollar resulted in a £2m non-cash IFRS credit to profits due to ‘mark-to-market’ value accounting on foreign exchange contracts and derivative financial instruments. A significant proportion of purchases are made in US dollars so the company sensibly hedges the foreign exchange risk by using such instruments. Bearing this in mind sterling has weakened by 5.5 per cent against the US dollar since mid-June, hence the accounting gain on these currency hedges.
The greater than expected increase in profits aside, cash generation was better than I had anticipated with Character ending the financial year with net funds of £4.5m, reversing a net debt position of £4.5m in August 2014, having generated more than £18m of cash inflow from operating activities in the 12 month trading period. This robust cash generation also enabled the company to repurchase £6m of shares at 260p each, pay £1.8m in dividends and invest a similar sum in the business. The final payout has been increased by a fifth to 6p a share, so the 51 per cent rise in the full-year dividend to 11p was better than I had anticipated too.
Importantly, prospects for the coming year are looking very positive, so much so that analyst Myles McNulty at joint house broker Allenby Capital upgraded his current year underlying pre-tax profit estimate by 4 per cent to £12.5m to give EPS of 48.6p and expects a 10 per cent rise in the dividend per share to 12.1p. But I can see definite upside to these profit forecasts as the re-launch of children’s favourite Teletubbies on CBBC last month is being accompanied by a new line of toy products featuring these characters early next year. Teletubbies brand owner DHX Media commissioned a new series of 61 episodes and Character Group is the appointed 'Global toy partner'. Shipment of the new Teletubbies product range started last month ahead of going on sale in the third week of January at all major UK retailers.
Teletubbies to spark upgrades
Bearing this in mind, the potential for sales could be massive given that Teletubbies was generating $2bn (£1.3bn) in revenues globally at its peak, having been screened in 120 countries and produced in 45 languages since 1997. In aggregate, more than 1bn children worldwide have viewed the programme. To put that into some perspective, Character's best selling product range, Peppa Pig, generates around $1bn in annual revenues, or half the level of Teletubbies at its peak. Character has been a partner of Peppa Pig’s owner Entertainment One (ETO) for over a decade now, and its toy products are distributed in almost 20 countries.
Television viewing data suggests demand for Teletubbies toys could be massive: in the first week of the re-launch by the BBC on CBeebies, the channel took 66 per cent share of the audience for children up to three years old, up from 49 per cent the prior week, and smashed Channel 5’s Milkshake!, featuring children’s favourites Bob the Builder and Thomas & Friends, into a distant second with a 17 per cent share.
It’s worth noting that Character’s top cornerstone brands, accounting for more than three quarters of its annual sales, are clearly outpacing the growing UK toy market. These include Fireman Sam, licensed from US toy giant Mattel (US: MAT), and Scooby Doo, licensed from media group Warner Bros Entertainment. Other toy brands sold by Character on behalf of overseas owners include Minecraft which is owned by Microsoft (US: MSFT) and out licensed to Jazzwares; Teksta by Toyquest; Little Live Pets by Moose Enterprises; and the BBC’s Timelord, Doctor Who. These are valuable portfolio assets offering a lucrative revenue stream for the company through licence agreements.
True, domestic sales which account for almost three quarters of Character’s total revenue have been outperforming those from overseas, but they are higher margin too. In any case, I see the underperformance of international sales as a temporary blip especially as the potential for the Teletubbies brand overseas and the launch of a number of key products ahead of Christmas.
New target price
So with Character’s shares trading on 10 times earnings, offering a 2.5 per cent prospective dividend yield, and the board committed to continuing its policy of making earnings accretive share buy backs, then I feel the upside from the Teletubbies toy launch next month is being seriously underestimated by investors.
In fact, having seen the shares hit my target price of 525p ahead of a pre-close trading update at which point I recommended running profits (‘Four small caps with further to go’, 10 September 2015), I now rate them an outright buy again on a bid-offer spread of 480p to 485p given there is almost 25 per cent upside to my new target price of 600p. If achieved this would value the company’s equity at £130m, or the equivalent of 13 times earnings. Please note that I first advised buying the shares at 415p six months ago ('Playtime', 1 June 2015). Buy.
Please note that for a limited period of time, my book Stock Picking for Profit is being offered for sale at a promotional price of £11.99 plus postage, subject to availability, full details enclosed below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies since the start of last week:
■ Ensor: Buy at 99p, target 125p ('Bid watch', 23 Nov 2015)
■ Marwyn Value Investors: Buy at 216p ('Cashing in on a top performer', 23 Nov 2015)
■ Trakm8: Run profits at 262p ('On track for record earnings', 24 Nov 2015)
■ Walker Crips Group: Buy at 49p, target 60p ('Profit from a profit surge', 24 Nov 2015)
■ Renew Holdings: Buy at 362p, new target range 390p to 400p; Cambria Automobiles: Buy at 73p, new target 90p; Tristel: Run profits at 142p; Pure Wafer: Sit tight at 165p and await details of capital distribution ('Running small cap winners', 25 November 2015)
■ Cohort: Run profits at 418p; Inland Homes: Run profits at 70p ('Riding momentum stocks', 26 November 2015)
■ Record: Hold at 28.75p ('Record awaits the Fed decision', 26 November 2015)
■ First Property: Run profits at 47.5p ('Investing for bumper gains', 30 November 2015)
■ Paragon: Run profits at 384p; Redde: Run profits at 174p; Fairpoint: Run profits at 175p ('Capitalising on investor overreactions', 1 December 2015)
■ LMS Capital: Tender your pro-rata allocation ('LMS tender on the money', 1 December 2015)
■ Vertu Motors: Buy at 78p, new target range of 85p to 90p (‘In the fast lane’, 2 December 2015)
■ MS International: Run profits at 210p, target bull market high of 240p (‘Engineered recovery’, 2 December 2015)
■ Mountview Estates: Buy at 11,500p (‘Mountview’s accounts reveal hidden value’, 2 December 2015)
■ Character Group: Buy at 485p, new target 600p (‘Playtime for a popular Character’, 2 December 2015)
■ For a limited period and strictly subject to stock availability, Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com at a special promotional price of £11.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
