Games Workshop resisting rising costs

Games Workshop (GAW) sells miniature figurines which need to be produced and then distributed across the world. Like most retailers, distribution was difficult this year. Shipping costs increased and logistical difficulties meant there was too much inventory. These issues have squeezed margins and lowered free cash flow.

In reality, Games Workshop isn’t just a retailer. It produces very popular IP and creates a community for its customers. Warhammer fans are loyal because the stories told through the figurines, books and computer games are compelling. They also love it because it creates a space to socialise with friends, either online or in the 518 retail stores across those 23 countries.

The loyalty of fans can be seen in the robust top line. Revenue increased 12 per cent to £419mn, which helped push up operating profit by 4 per cent to £157mn. Sales are increasingly being bolstered by licensing revenue, which was up 72 per cent to £28mn.

This is still only 7 per cent of the total revenue, but offers an interesting growth area in a world where shipping internationally is becoming increasingly difficult. Just over 80 per cent of the licensing revenue came from PC and console games. There are 12 unreleased games in development and growing this sales line will be an important way to protect margins if costs keep rising. The gross margin fell 5.6 percentage points to 67.1 per cent because of a £9.2mn increase in freight costs.

Another way to offset some of these costs is through price increases. Management has increased prices around 5 per cent for the Warhammer figurines. Given the pricing power of the IP, customers should be willing to accept these rises. However, management is keen not to squeeze their community too hard. Network effects are important for the business and keeping fans onside in the short-run will have long-term benefits.

Broker Peel Hunt pointed out that “hobbies tend to be pretty resilient during a recession” as evidenced during the 2008 crash. Given this, the broker expects operating profit to stick at a healthy 40 per cent despite rising costs.

The forward PE ratio has fallen from 30 in August last year to 19. This shift can be justified by the rising costs and higher interest rates. However, the fundamentals of the business haven’t changed. The IP and sense of community are strong as ever. For investors, those are strong defensive qualities. Buy.