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Games Workshop sheds its fantasy valuation

After a big drop, Games Workshop shares once again offer a high return on equity at a compelling price
Games Workshop sheds its fantasy valuation

One of the more unusual investment themes of recent times has been the rise of non-fungible tokens (NFTs). Many commentators derided the $41bn (£31.5bn) spent on them in 2021 but for those in the know, the value was clear. It was – and still is – all about the community. If you owned an NFT it gave you the right to attend events with other owners of the NFT and perhaps bond over the criticism you receive from the rest of the world.

Tip style
Risk rating
Long Term
Bull points
  • Strong cash generation
  • High return on equity
  • Strong brand helps pricing power
  • Increasing revenue from IP licensing
Bear points
  • Rising wage inflation
  • Cost of living might lower demand
  • Slowing revenue growth

NFT creators weren’t the first entrepreneurs to tap into the value of a shared sense of identity afforded by a minority pursuit. Games Workshop (GAW), which was founded in the 1970s, created the fantasy tabletop-based game Warhammer in 1983. To play the game, you must purchase and paint miniature models. The Games Workshop stores provide a physical space for gamers to meet and play with each other.

The community has continued to grow since the 1980s and in the last year the Games Workshop email list had 21.2mn cumulative opens. Its creative intellectual property (IP) has spawned hundreds of books, as well as TV series, animation, and video games. Although all the tabletop models are still made in Nottingham, Warhammer distributes to fans across the world including Europe, America, Asia and Australia.


The fanatical nature of Games Workshop’s customers, alongside a completely unique and differentiated product offering, translates into strong financial performance. Being a Warhammer fan is not cheap, but fans are willing to spend. In its last full financial year to May 2021, the company’s gross margin was 72.7 per cent and its return on equity was 73.9 per cent. At £353.2mn, sales were up 38 per cent on 2019’s pre-pandemic high.

Until recently, the combination of strong market growth and high returns on investment had also made Games Workshop a darling of the stock market. Between 2018 and the summer of 2021 its share price more than quadrupled, climbing to more than 30 times forward earnings in the process. However, in the last six months investor sentiment has decidedly cooled.

Supply chain woes sap confidence

In the half-year to 28 November 2021, profit before tax fell 3.9 per cent and the gross margin dipped six percentage points to 70 per cent, following a £5.6mn rise in input and carriage costs and a £3mn jump in staff costs.

From the company’s two factories in Nottingham, international orders of models are shipped to centres in Tennessee and Sydney before being taken to local stores. This process requires a lot of transport and, as any informed investor will know, the price of shipping has increased substantially in the last year. Over 75 per cent of revenue is generated internationally.

In total, rising shipping costs accounted for half of the first half’s gross margin dip. Hold-ups in the supply chain also meant a £6.6mn increase in inventories and a £32mn rise in trade and receivables. With more working capital tied up, net operating cash dropped 31 per cent to £76.5mn.

Management said these delays meant the business hasn’t “delivered to its full potential” and joined the growing chorus of businesses who expected disruptions to ease over the winter. Such predictions initially failed to materialise, although the price of shipping has started to fall quite consistently since the start of March. In the last month, the Drewry World Container Index has shown a 13 per cent fall to $8,000 per 40ft container.

This is still 60 per cent higher than April last year but down significantly from a September high of $10,000.

As the pandemic splurge on consumer goods in the US and Europe eases, demand for container space should continue to fall, and help Games Workshop's gross margin head back toward historical levels.


Growing IP royalties

To offset some of the rising costs, Games Workshop has recently turned to opportunities from its extremely popular intellectual property (IP). In the six months to November, royalties received more than doubled to £20.1mn. To put this in to perspective, just £1.5mn was generated from royalties in the whole of 2015. The company stresses that royalty income isn’t consistent but in the last few years it has been steadily rising.

This year, the company is releasing several “major video games”, including Total War: Warhammer 3 and Warhammer 40,000: Darktide and Lost Crusade. So far, Total War: Warhammer 3 has been well received by fans and critics. There are also plans to launch a computer game in Age of Sigmar, a new fantasy world launched in July last year. A trailer for the title was viewed more than 28mn times, which management hailed as “the best fantasy launch to date by a considerable margin”.

In short, the issues in the last year seem to have little to do with a lack of demand from Warhammer fans.


Capital for hard assets, too

Although the digital world of gaming and animation offers new avenues for revenue, management hasn’t forgotten to keep investing in its manufacturing capabilities. In the first half of the year, £2.6mn has been ploughed into capital projects.

In the Nottingham factories, five more injection moulding machines have been installed, bringing the total number up to 43. Meanwhile, in the Memphis facility new technology has “significantly increased” the speed with which orders can be packed. This improvement enabled the £5mn of back orders at the end of November to be cleared in early January.

Speeding up the processing of orders will help improve operating cash flow by clearing the receivables faster. The improved efficiency from capital investment is presumably part of the reason why management was able to declare a special interim dividend of 70p per share to investors at the end of March, payable to shareholders on the register on 1 April.

Brokers seem confident that cash flow will continue to improve over the next couple years. FactSet consensus is for £155mn of free cash flow in 2022, rising to £175mn in 2024. This gives a very healthy 2024 free cash flow yield of 7.1 per cent.

Games Workshop's high return on equity and strong cash generation has meant that it has been a very pricy stock. As recently as May last year, it was trading on a forward price/earnings (PE) ratio of 30.6. However, the recent supply chain issues and margin reduction means that the market has gone a little cold and it is now trading on a more affordable ratio of 19.3 times.

Pessimists may point towards the cost-of-living crisis as a reason for caution. As the price of food and home bills rise, shelling out for another new miniature model might start to feel like an unaffordable luxury. However, brand strength confers pricing power and few companies have as much customer loyalty as Warhammer. You need only look at the 70 per cent gross margins for the evidence.

Speaking about the Warhammer franchise, Superman actor Henry Cavill, said he “genuinely can't get enough of the lore they have built over the decades”. There are very few products out there with such glowing endorsements and the recent re-rating offers an attractive entry point into this world. NFTs might be a fad but Warhammer has the track record to suggest it is here to stay.

Company DetailsNameMkt CapPrice52-Wk Hi/Lo
Games Workshop  (GAW)£2.50bn7,600p12,310p / 6,365p
Size/DebtNAV per shareNet Cash / Debt (-)5yr NAV CAGROp Cash/ Ebitda
ValuationFwd PE (+12mths)Fwd DY (+12mths)FCF yld (+12mths)EV/ EBITDA
Quality/ GrowthEBIT MarginROCE5yr Sales CAGR5yr EPS CAGR
Forecasts/ MomentumFwd EPS grth NTMFwd EPS grth STM3-mth Mom3-mth Fwd EPS change%
Year End 31 MaySales (£m)Profit before tax (£m)EPS (p)DPS (p)
f'cst 2022384158383228
f'cst 2023416165393244
chg (%)+8+4+3+7
Source: FactSet, adjusted PTP and EPS figures
NTM = Next Twelve Months
STM = Second Twelve Months (i.e. one year from now)