Interactive Investor

Stockwatch: a game-changer for Games Workshop worthy of upgrade?

20th December 2022 11:00

by Edmond Jackson from interactive investor

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A possible tie-up with Amazon is hugely exciting and traders have been quick to price in a value. Analyst Edmond Jackson gives his opinion and current rating for the popular shares.

Games Workshop 600x400

Might a film and TV deal offer substance to reinforce a new bull trend for this fantasy miniature war games manufacturer? 

The FTSE 250 index is generally seen as bearish territory at the moment as domestic businesses face potentially a tough long recession.  

Yet last Friday, Games Workshop (LSE:GAW) rose 16% to 8,480p and continued to edge up yesterday to 8,550p. The catalyst is an “Agreement in principle” for Amazon (NASDAQ:AMZN), to develop film and TV for the UK company’s intellectual property (IP). 

Warhammer, a table-top war game, would be made into film/TV starring ex-Superman actor Henry Cavill, who will also produce the adaptation. 

Something new is required on a grand scale  

Games Workshop’s licensing income has otherwise consolidated, possibly to around £17 million annually relative to £200 million or so revenue from games. Profit growth needs a new angle after Covid lockdowns boosted online sales.  

Otherwise, the stock has looked exposed on a growth-type price/earnings (PE) multiple versus a broadly flat earnings scenario for the May 2023 and 2024 years. There is a respectable dividend record, but consensus for a circa 3% prospective yield at the current share price assumes a 54% hike in the total pay-out, with earnings cover reducing from 2.4x near 1.5x. 

Hedge fund GLG Partners raised a short position from the 0.5% disclosure threshold last spring to 0.75% by end-September – a not immaterial bet against a circa £2.5 billion company. GLG fortunately reduced this to 0.4% as of 7 December.  

Amazon has declared: “This is the first deal of its kind for Amazon Studios for IP of this scale, allowing use of the Warhammer title across its entertainment businesses...We are excited to work with Games Workshop...for our global customers to experience for years to come.”  

Potential step change for public awareness of Warhammer products 

A 17% re-rating implies the market values this deal at around £400 million, which prices in plenty before any terms are declared.  

But, if successful, it could also be a marketing coup, raising global awareness of Warhammer and boosts sales of games. 

The announcement was, however, ambiguous as to “granting Amazon associated merchandising rights”: does that imply the T-shirt, so to speak, or products as well?  

The latter could be a good thing if terms are fair on Games Workshop and Amazon flexes its marketing muscle; but where powerful American firms are concerned, you need to beware of exploitation.  

Amazon already sells Warhammer sets on behalf of Games Workshop so it would not be surprising if this retailer wants to leverage product sales as a result of its film/TV initiative.  

Interest rate and company-specific issues drive this stock 

Apart from this latest re-rate, macro factors have appeared to prevail – specifically, changes in interest rate expectations as they affect growth stocks. Have we come to the end of an era since 2008, when “growth” was greatly preferred over “value” amid ultra-low rates? 

When I examined Games Workshop last March at 7,150p, it had de-rated over 40% from a September 2021 all-time high of 12,220p, similar to many other growth stocks as markets anticipated higher interest rates.  

Theoretically, this reduces long-term returns from higher-growth companies when discounted to a net present value. Yet Baillie Gifford, the Scottish fund manager, had doubled its stake in Games Workshop to 10%.  

Earnings per share (EPS) growth forecasts were low-single-digit percent versus an 18x PE multiple and a price/sales ratio was over 6x. How much of this gets excused by an operating margin of around 40%? 

Games Workshop Group - financial summary
Year end 29 May

Turnover (£ million)119118158221257270353387
Operating margin (%)13.814.324.233.631.633.443.040.6
Operating profit (£m)16.516.938.374.381.290.0152157
Net profit (£m)12.313.530.559.565.871.3122128
Reported EPS (p)38.342.094.5182201218371391
Normalised EPS (p)41.943.593.4182204219374395
Earnings per share growth (%)3.33.811495.411.57.670.95.5
Operating cashflow/share (p)72.775.4136214221319403370
Capex/share (p)38.639.439.765.968.675.191.198.3
Free cashflow/share (p)
Dividend per share (p)
Covered by earnings (x)
Cash (£m)12.611.817.928.529.452.985.271.4
Net debt (£m)-12.6-11.8-17.9-28.5-29.4-20.8-38.2-22.5
Net assets/share (p)161166196272328409599715

Source: historic company REFS and company accounts

As a fundamentals-driven analyst, I concluded that buying around 7,150p was more an act of faith that the drop on the chart would mean-revert. Stagflation could compromise toy sales and also raise manufacturing input costs. 

The stock had fallen to 6,000p by mid-June then re-bounded to over 7,500p, but had fallen again to below 5,700p by late September.  

This second low occurred in the wake of a 21 September update that cited trading for the three months to 28 August “in line” with expectations, despite like-for-like pre-tax profit down 13% to £39 million on revenue up 8% to £106 million. 

The stock then re-rated 33% to over 7,500p despite no company-specific news. It appeared chiefly sentiment recovering after the UK’s disastrous mini-budget that saw the chancellor and prime minister changed, and also (misplaced?) optimism that US inflation and interest rates would fall in 2023. 

A 7 December update ahead of 10 January interim results estimated a 10% decline in core revenue, and licensing revenue down 30% to £14 million. With core operating profit near flat at around £70 million, the element from licensing is down 31% to £13 million – hence pre-tax profit expected to be down around 6% to £83 million.  

The stock bumped along indifferently, as macro issues prevailed. 

Distinguishing Games Workshop over next two years 

Its re-rate may also reflect sensitivity – desperation even – for positive stories, when so much else involves “wait-and-see” for numbers and narratives to worsen. If the Amazon deal proves transformative, this stock is likely to enjoy some premium for scarcity.  

The company has also shown that its games cult following meant a resilient performance over the last major recession: revenue slipped in the May 2010 year only in constant currency terms, by 3% to £122 million (versus £419 million consensus for the May 2023 year) and pre-tax profit actually leapt 115% to £16 million.   

The CEO’s narrative back then explained this by way of “making the best war-gaming miniatures” for global customers, also a “hobby centre” marketing approach becoming part of communities. 

In the last financial year, the UK constituted just 22% of revenue, hence Games Workshop should not be seen as a domestic stock. Brexit has not impaired continental European revenue, which rose from 23% to 25% of total. The US remained dominant, rising from 41% to 44% - it is unclear whether government cash-hand-outs during Covid lockdowns helped, and that US revenue may temper. 

This re-rate appears likely to ease 

Ascribing circa £400 million of value to the effects of this deal seems highly speculative until more proof is seen, and I am not surprised that the stock has eased 2% to 8,385p today. 

Last January’s interim results provided no insights as to Christmas period trading, leaving the stock subject to influences of wider retail numbers. 

It is hard to see what can provide another catalyst in the near term unless substance of the Amazon deal proves especially good. 

Meanwhile, I am wary on the macro front, of how investors may not appreciate that interest rates will have to stay higher for longer if inflation is to be tackled. 

Holders can take some encouragement, however, that GLG may seek to further reduce its short position now the bear case is disrupted and potentially offers a long-term bull era. As a trade, it appears to have breached the notion of a trailing stop loss on the upside. 

I missed a buying opportunity last autumn and think Baillie Gifford deserves a hat-tip for making its own luck, doubling its stake last spring. Even so, I do not currently upgrade my stance. Hold.

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

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