Buy Games Workshop's growth wizardry

Games Workshop manufactures and sells miniature models of fantasy soldiers and mythical creatures, which its avid fans paint and use to stage mock battles and play rule-based fantasy games. It’s a niche market in which Games Workshop is the global leader and recent years have shown just how profitable it is to be the overlord of these fantasy realms. The group’s most recent half-year results reported a gross margin of 67 per cent and an operating margin close to 33 per cent.

The company operates 507 stores globally, which accounted for 37 per cent of last year’s revenue. A further 43 per cent of revenue came from trade sales – products sold through independent retailers, agents, distributors and the like – and 20 per cent from online. The relatively mature UK market accounts for 24 per cent of sales, and the less mature markets of continental Europe and North America account for 27 per cent and 38 per cent, respectively. A further 11 per cent comes from other regions.

As one might expect, Games Workshop’s products attract a very loyal following. Since 2015, after a five-year period refocusing the business and bringing down costs, the company has demonstrated its ability to create significant value from its intellectual property (IP), while winning new fans through a much improved online presence and social media engagement. The company has had huge success with new versions of its Warhammer games with more accessible rules. It has also increased its focus on new product innovation and has sought to manage new launches to make revenues less lumpy.

The value of the dedicated fan base has also been exploited by licensing its IP to third parties for use in other mediums, such as apparel and video games. The group’s last annual results reported royalties of £9.9m, £9.4m of which turned straight into profit. Video games appear to be the most lucrative potential market here, accounting for 89 per cent of royalties last year. In April, the group said it expected royalties to improve in the 2019 financial year, due to its signing new licensing agreements. This is a relatively volatile income stream that depends on third-party launches, but the company is looking at new areas to license into such as live action and animation, while trends in the video games industry to prolong game franchise lives could play to its favour.

The competitive advantage created by Games Workshop’s market leadership also puts it in a better position than rivals to invest in physical and digital infrastructure as well as product innovation. It recently expanded its Nottingham-based manufacturing facility at a cost of £14m, which house broker Peel Hunt thinks will increase its sales potential to more than £350m. It has also invested in new enterprise resource planning and digital asset management upgrades for its European operations, as well as software and warehousing upgrades in the group’s US operations in Memphis, Tennessee. It is worth noting that as well as capitalising (recording as an asset rather than an expense) these investments, a good chunk of product development costs are also capitalised – £5.4m of development costs were capitalised last year, including £4.3m of salaries.

After the rapid growth of recent years (see table) progress is expected to slow, with Peel Hunt forecasting a catch-up in costs. That said, Games Workshop is still proving very capable of surprising on the upside. The latest trading statement said management expects to report full-year profits of around £80m, a full £10m ahead of the broker’s previous £70m prediction.

Core post-tax cash generation has grown strongly in recent years, although it dropped 28 per cent in the six months to December due to investment in working capital, as the group built inventories to support higher sales over the Christmas period. The company does not have a dividend target as such, but has a policy of distributing excess cash, and its latest quarterly dividend of 35p brings the 2019 payment to 155p a share, equivalent to a near-4 per cent yield.