Interactive Investor

Stockwatch: Baillie Gifford doubles stake in fallen growth star, but should you? 

18th March 2022 10:45

by Edmond Jackson from interactive investor

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Our companies analyst tries to make the numbers stack up at this business which has developed a cult following.

warhammer games workshop fantasy 600

At around 7,150p, the shares in mid-cap miniature games group Games Workshop Group (LSE:GAW)are down 42% from a 12,220p all-time high last September - one of the starker UK de-ratings among those perceived as growth stocks. 

You could say this wipes off the froth, after growth stocks soared from March 2020 amid ultra-low interest rates and monetary expansion in response to Covid – including direct cash hand-outs in the US, where this company derives 44% of its revenue.  

Baillie Gifford implicitly believes so. The Scottish fund manager has doubled its stake to 10% of this £2.2 billion company. Its capitalisation can look rich at over 6x annual sales; however, a 37% interim operating margin (even before royalties and at constant currency) means the 12-month forward price/earnings (PE) ratio is around 18x. 

That looks plenty high enough, based on consensus for low single-digit growth in the next two financial years to May 2023. You have to believe that its customers are sufficiently addicted, and that the company is innovative with its miniature games, to anticipate a renewed wave of growth.  

That requires some foresight as living costs soar, compromising consumer discretionary spending; yet even in recessions, there are consumer stocks that surprise on the upside. 

Is this a genuine support level to help restore an uptrend? 

The stock has been hit by a double whammy: ‘top-down’, from capital re-allocation out of growth stocks generally, and ‘bottom-up’, as earnings per share (EPS) growth has faltered. In the first half year to 28 November, it eased 4% to 217p amid cost pressures. 

Having hit 6,365p on 8 March, the stock is finding support – but so is much else after the markets plunge in reaction to war in Ukraine. Yesterdays mark-up to over 7,200p followed by a steady drift to 7,050p, closing at 7,100p, is in sympathy.  

It still looks a classic mean reversion – back to a trend-line from around March 2017 – after a blowout rally from March 2020 to September 2021.  

Hopes were raised after lockdowns and support payments in the western world appeared supportive for hobby-gaming; additionally, monetary expansion and ultra-low interest rates boosted growth stocks. But an inflection point was hit last autumn, with expectations of monetary policy tightening and costs of living rising.  

It makes Games Workshop an intriguing test of the validity of technical analysis versus fundamentals: the rebound affirms a broad chart view that this stock is once again in a buying range, but is this backed by fundamentals?  

The context has implied a need for fresh growth drivers 

I last reviewed Games Workshop a year ago at 9,400p, when it had dropped from a then all-time high of 11,650p that January. Consensus expected around £120 million net profit, implying a prospective PE of around 25x. Despite paying out roughly half of earnings, the yield was sub-2.5% – so there was no prop, should earnings growth falter. 

I noted that a past chairman of 20 years had sold half his holding at £97.21, and several institutions had trimmed their stakes. 

I thought it best to be locking in gains, and to avoid the stock with fresh money, not least because growth stocks were exposed to profit-taking generally. It only needed expectations to shift away from exceptionally low interest rates.  

While £122 million of net profit achieved was a slight beat for the year to May 2021, loss of material earnings growth means the price/earnings-to-growth – or PEG – ratio is now around 5x.

The PEG ratio can get skewed in the near term, but this classic growth stock measure is supposed to imply value when below 1.0x and occasionally 1.5x.  

Buyers therefore need confidence that Games Workshop could beat May 2023 expectations, or certainly that renewed vigour will manifest thereafter. 

Recent company outlook statements have been opaque 

At last Julys annual results, the CEO gave a tribute to the workforce and a spirited rallying call, rather than any guidance on performance. 

Then a 16 September update cited trading for the three months to 29 August in line with the boards expectations, with "growing” revenues, albeit not quantified. As with other businesses, we have seen pressure on freight costs and currency exchange rates.” 

The mixed news conflated with money shifting out of growth stocks, taking Games Workshop down from 12,220p to below 10,000p.  

The stock consolidated until the end of 2021, barely responding to an in line” update on 8 December that cited sales of not less than £190 million for the six months to 28 November (up 2% year-on-year), and pre-tax profit not less than £86 million (down 6%).  Operating profit was estimated down some £15 million due to extra costs including higher pay. 

After the 11 January interims the stock dropped again, showing net profit down 4% to £71 million on revenue up 3% to £192 million. The CEO proclaimed our best performance ever” tinged with disappointment that the company had not been able to deliver full potential, due to delays in new product launches amid supply disruptions.  

Games Workshop Group - financial summary
year end 30 May2015201620172018201920202021
Turnover (£ million)119118158221257270353
Operating margin (%)13.814.324.233.631.633.443.0
Operating profit (£m)16.516.938.374.381.290.0152
Net profit (£m)12.313.530.559.565.871.3122
Reported EPS (p)38.342.094.5182201218371
Normalised EPS (p)41.943.593.4182204219374
Earnings per share growth (%)3.33.811495.411.57.670.8
Price/earnings multiple (x)19.0
Operating cashflow/share (p)72.775.4136214221319403
Capex/share (p)38.639.439.765.968.675.191.1
Free cashflow/share (p)
Dividend per share (p)
Yield (%)2.6
Covered by earnings (x)
Cash (£m)12.611.817.928.529.452.985.2
Net debt (£m)-12.6-11.8-17.9-28.5-29.4-20.8-38.2
Net assets/share (p)161166196272328409599
Source: historic Company REFS and company accounts

Such a narrative is not out of step with many companies currently. But Games Workshop maintained a vague in line with expectations” without specifying them. I am wary of situations where it can appear that investors are up against a small number of analysts essentially publishing guidance. Companies could quash this by including all the relevant numbers in their updates. 

Can Games Workshop pass on price rises and keep growing revenue? 

This to me is the crux question on fundamentals.

The latest update on 7 March saw many” of its prices go up by about 5%, such as a box of Space Marine Intercessors from £35 to £36”.  “A few things” rose about 10% such as books, scenery, resin miniatures; and Blood Bowl teams and metal miniatures by some 20%”. 

Painting products and starter sets, where it makes sense not to discourage new customers, are not going up in price. 

It looks as if the weighted average rise is 7% or higher, which is significant versus – we are told – the highest jump in the cost of living since the 1970s that is now underway. 

Quite where this will leave discretionary spending among Games Workshop customers is unclear. How dedicated are they as hobbyists, and what level of wage increases may they receive?  

Various games are sub-£50, however, and for example the latest Kill Team: Nachmund” full board game including 20 miniatures and a full set of terrain is currently £115. It is not like a decision on a new kitchen or furnishings. 

Maybe this is not prohibitive pricing if you are hooked on the hobby. Addicts seem to become so when young, and it can persist – such that the Warhammer games have been described as heroin for middle-class nerds”. 

GLG Partners declared a 0.53% short on 7 March

Investment manager GLG is the sole trader over the 0.5% of issued share capital, the level at which disclosure is required, although looking at the 33 other stocks where GLG is short, this is a pretty astute trader. 

In the short term I concur with GLGs implied scepticism: the stock rating remains fundamentally high versus a risk, and the rise in the cost of living will compromise sales growth as well as affecting input costs, thereby limiting the extent of any earnings rebound. 

At this price, buyers are therefore trusting that Games Workshop's cult following extends sufficiently to its stock, putting faith in the chart above the raw numbers. At around 7,150p to buy, more substance and conviction is needed on prospects. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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