A fantasy company at a fair price

But Games Workshop (GAW) shares were marked down by over 10 per cent on the back of a half-year update last week which, along with confirming a £3mn increase in employee profit share scheme payouts, revealed softer trading in the wargame miniature maker’s second quarter.

For the six months to 26 November, the company expects core revenue to have grown by at least 11 per cent to £235mn. That would mean there has been a slowdown since late summer, given the 14 per cent uplift in the first quarter. And interim licensing revenue is expected to have fallen from £14.3mn to around £12mn year on year (although analysts still expect this to grow over the full year).

Although they were “surprised by the extent of the slowdown”, analysts at Jefferies had expected a softer comparative period following June’s release of the Leviathan boxset containing the latest edition of the Warhammer 40,000 game.

Part of the story behind the share fall is that the company is a victim of its own success. The market has come to expect upgrades from Games Workshop, given its outperformance during the pandemic and an expectation-beating update in September. With the share price now back to where it was in June, investors have an opportunity to buy into a highly attractive business at a more compelling valuation.

The (business) model

The core of Games Workshop’s business remains the sale of fantasy models (from the worlds of Warhammer to the Lord of the Rings) which are glued together, painted and engaged in tabletop warfare by enthusiasts.

Revenue here is split into three sales channels and makes up 95 per cent of the top line. Trade sales to independent retailers, agents and distributors contributed 56 per cent of core revenue in the 2023 financial year, with a growing reliance on trade accounts bringing third-party risks as well as opportunities. High-street retail revenue is in second place, with online sales close behind. The strategy is for the three streams to grow “in harmony" over the long term. 

The manufacturing is done in England, with factories, main warehouses and other key functions located in or around Nottingham. But overseas markets take over three-quarters of revenue. Most stores sit in North America, followed by Europe and the UK, and there is a smaller presence in Australia and Asia. For stock management, there are warehouse hubs in Tennessee and Sydney, which proved to be the source of some higher shipping costs and supply chain headwinds during the pandemic. 

North America is by far the key revenue driver, delivering £197mn of core revenue in the latest year. This was more than double the amount posted in the UK and almost £100mn more than in Europe. Consumers on the other side of the Atlantic have bought into the world of Warhammer. 

Revenue is also taken from the granting of intellectual property (IP) licences to external partners, with most of this currently coming from video games. Some eyebrows have been raised about the company's accounting for these fees, with most income recognised when a contract is signed, but this is in line with the standards and isn't overly aggressive in our view. 

Capital investment, meanwhile, came in at £14.6mn in the latest year and £17.7mn the year before. Money is being spent on moulding tools to paint machines to ensure that the fans have new characters and fantasy storylines to play with and that Games Workshop retains its position at the top of the hobby tree.

Growth drivers

Games Workshop shares have delivered stupendous returns for investors since listing in 1994, and have almost tripled over the past five years, despite a purveyor of tabletop orc armies not perhaps being an obvious stock exchange victor. But the big question now is where future growth is going to come from.

One place to look is further expansion in international markets. Revenue is low in countries such as Japan and China, where further penetration is vfeasible. The company now has accreditation for "all relevant core products" in China, according to management. 

Analysts at Panmure Gordon point to lower revenues per capita in North America and continental Europe as evidence that the company has “plenty of room” for further growth overseas.

A strategic push to improve engagement with fans is another thing to watch. At its centre has been a beefier social media presence and chief executive Kevin Rountree's efforts to change up pricing to attract more customers. Monthly visits to the Warhammer community website are 3mn higher than pre-pandemic levels, suggesting that interest in the company's products continues to grow. 

This goes hand in hand with strong brand equity, which has in turn supported demand for the company's products and a loyal fanbase apparently willing to shell out for new launches and titles despite other cost-of-living pressures. Such a resilient economic moat has provided management with the confidence to issue guidance for pre-tax profits to rise by at least £10mn against last year. 

And while the expected fall in interim licensing revenue this year highlights the volatility of that sales line, there is significant potential with the company’s intellectual property (IP). 

Looking ahead, the company should receive a material boost if a potential deal for Amazon (US:AMZN) to develop its IP into film and television shows is signed. Contract negotiations are ongoing a year after the agreement in principle was first announced, and investors should bear in mind that the entertainment environment is challenging, with content spend falling at companies such as Walt Disney Co (US:DIS) and Netflix (US:NFLX).

Analysts expect profits to grow in the coming years as the company exploits such opportunities and makes further capital investment, although a 13 per cent earnings uplift in 2024 is currently forecast to be the peak. In the short term, the release of new tabletop game Warhammer: The Old World in early 2024 should provide a boost.

Model metrics

Behind the share price growth sit some attractive financial metrics. Importantly for income-hungry investors, dividends are growing. Dividends declared and paid so far this financial year come to 195p a share, up from 165p last year, with management reiterating that it aims to return surplus capital. The company is in a net cash position, helpful both in the sense of lessening exposure to higher interest rates and supporting future payouts through a strong balance sheet. 

Strong brand loyalty also translates into strong pricing power, as reflected in gross margins that have been a very attractive 70 per cent in recent years. Future margins should be supported by production efficiencies, with new equipment and systems at warehouses being deployed across the company's markets. 

A high return on capital employed (ROCE) highlights that capital is being profitably invested, with an average core business ROCE in the latest year of 133 per cent. While the latest annual return on equity figure fell year on year, a five-year average of 64 per cent is very nice indeed.  

Games Workshop has had a fantastical valuation in the past, with a price/earnings ratio of 40 times back in 2020. After the recent share price fall, the rating is now a much less demanding 20 times forward consensus earnings. That’s a fifth below the five-year average and means investors can bank an enticing yield from those growing dividends.

On balance, this all adds up to an acceptable price for an excellent business, underpinned by a deep franchise, strong track record and management, growth prospects and financial strengths.