The Retail King: Games Workshop
Summary
- Games Workshop continues to experience strong (but slowing) growth.
- Retail channel has been transformed in recent years.
- Cash-flows remain high, thus dividends remain stable with an outlook for further growth.
Investment Thesis
Games Workshop (GAW) continues to deliver high growth and exceptional margins through 2018, with an outlook for continued (but slowing) growth through 2019 across all major segments of the business. Noteworthy is the continued underlying strength of the retail division during otherwise uncertain times for the British high-street.
Background of Games Workshop
Games Workshop has been perfecting the art of high-quality miniatures since 1975, and this 43-year tenure has positioned the company for exceptional performance as growth in gaming continues at record rates throughout much of the developed world (Claremont, 2014). During this time, it has developed some of the most complex and complete fantasy and sci-fi universes that rival the likes of Star Wars and Lord of the Rings.
Kevin D. Rountree took over the role of CEO in 2015 and has exceeded expectations ever since. Since then, a number of successful changes have been made across the group.
A Volatile Retail Record
Year | Retail Operating Profit: | Change | Retail Operating Expenses: | Retail Revenues |
2015 | (£1,510,000) | £33,934,000 | £49,060,000 | |
2016 | (£3,410,000) | (£1.9m) | £35,930,000 | £48,414,000 |
2017 | £461,000 | £3.9m | £42,849,000 | £64,800,000 |
2018 | £7,185,000 | +1458% / £6.7m | £45,992,000 | £82,000,000 |
2019 | £7,840,000 | +9% | £49,135,500 | £89,100,000 |
2020 | £8,467,000 | +8% | £53,065,000 | £96,228,000 |
Operating profit above is inclusive of impairment, depreciation and amortization charges. Furthermore, absolute values are used in negative years as percentages would not fairly represent material changes in the business. There is a case that this argument should be extended to 2018, due to the percentage growth from a small base, hence the inclusion of both absolute and percentage data during this year.
Forward looking projections during 2019 and 2020 are based on conservative estimates. There are a number of headwinds facing the retail segment this year, including Brexit and upward cost pressures due to labor tightening and a diminishing field of excellent managers from which to hire hampering UK retail expansion.
Opex forward projections are calculated from the 2017-2018 growth increases, extrapolated to more accurately reflect the retail headwinds and slower growth through 2019 and 2020.
It should be noted that half year results have held up particularly well at £4.9m, but as management have highlighted in recent reports, 2019 has a series of challenges resulting in the primary reasoning for the slight downgrade in projected full year earnings.
Retail revenue continues to grow at an excellent rate. The current levels of growth are expected to be lower through 2019, and it will be dependent on the logistical and supply capacity increases implemented by 2020 to provide the necessary infrastructure for future growth.
2019 Retail Growth Prospects
Boasting a total of 462 stores Games Workshop continues to extend its reach beyond its original UK borders. The data below suggests the change to one-man stores is an on-going process, with further reductions in multi-manned stores to 110. This serves to reinforce profitable growth, and is a format that has radically transformed the retail division in recent years (Games Workshop, 2018).
Total Stores: | May 2017 | Opened | Closed | June 2018 | One man stores 2018 | One man stores 2017 |
UK | 147 | 6 | (9) | 144 | 104 | 114 |
North America | 111 | 25 | (2) | 134 | 119 | 96 |
Continental Europe | 145 | 6 | (3) | 148 | 103 | 100 |
Australia | 47 | 3 | (2) | 48 | 39 | 39 |
Asia | 12 | 3 | - | 15 | 14 | 11 |
Total | 462 | 43 | (16) | 489 | 379 | 360 |
(Games Workshop 2017-18 Annual Report, 2018)
As the company moves through 2019, the primary areas of retail growth are likely to include North America and Germany. North America continues to develop an appetite for the grim-dark products of Games Workshop. While it is already a market of importance, the warehousing upgrades in Memphis will increase efficiency and capacity, alleviating logistical issues of growing revenues to a consistent £200m+ per year base.
Similar upgrades in Nottingham set the stage for increasing supply capacities for growth in Europe, and notably Germany during 2019.
DCF Model for Games Workshop Retail Division: 10-year Projections
2018 | 2019 | 2020 | 2021 | 2022 | |
Revenues | £82,500,000 | £89,100,000 | £96,228,000 | £103,926,240 | £112,240,339 |
Operating Profits | £6,700,000 | £7,840,000 | £8,467,000 | £9,144,360 | £9,875,909 |
Tax at 21% | £1,407,000 | £1,646,400 | £1,778,070 | £1,920,316 | £2,073,941 |
Actualised Free Cash | £5,293,000 | £6,193,600 | £6,688,930 | £7,224,044 | £7,801,968 |
Discounted Cash Flow | £5,040,952 | £5,617,778 | £5,778,149 | £5,943,239 | £6,113,046 |
2023 | 2024 | 2025 | 2026 | 2027 | |
Revenues | £121,219,566 | £130,917,132 | £141,390,502 | £152,701,742 | £164,917,882 |
Operating Profits | £10,665,982 | £11,519,260 | £12,440,801 | £13,436,065 | £14,510,950 |
Tax at 21% | £2,239,856 | £2,419,045 | £2,612,568 | £2,821,574 | £3,047,300 |
Actualised Free Cash Flow | £8,426,125 | £9,100,215 | £9,828,233 | £10,614,491 | £11,463,651 |
Discounted Cash Flow | £6,287,704 | £6,467,353 | £6,652,135 | £6,842,196 | £7,037,687 |
Assumptions: | |
Discount Rate | 5% |
Growth Rate | 8% |
Tax Rate | 21% |
Total 10-Year Value of Retail Segment | £61,780,240 |
(Games Workshop 2017-18 Annual Report, 2018)
Operating profit figures above are inclusive of impairment, depreciation and amortisation. There is no specific data on capex requirements of store openings, and thus it is difficult to gauge the material significance to the value of the firm.
As noted above the overall growth rate is slowing, but the January trading update indicates 9% retail growth through 2019.
Authors View on Growth
Games Workshop possesses no meaningful debt and excellent cash-flow, facilitating (on average) around 40% of profits back to shareholders in the form of dividends. As growth continues to slow investors have voiced increasing concerns over the prevailing wisdom in returning such a level of surplus cash back to shareholders. There is a case to be made for increased profit retention to further expand capex in a meaningful way (Trading Update, 2018).
However, as a shareholder the authors view is that growth of 8% in retail is highly satisfactory, so long as this growth maintains current margins. Expecting double digit increases year on year is neither sustainable or sensible given the growing uncertainty at present. The reduction in risk, in the authors opinion is worth the trade-off. While profits remain excellent today, it is worth noting the consistent retail losses Games Workshop has suffered in recent history, and the importance of not returning to that position in the future (Financial Times, 2018).
Retail Headwinds & Opportunities
Growth is expected to stabilise at circa 9% for 2019, and while this is substantially lower than recent years, it is firmly acceptable growth. Arguably, cautious growth during 2019 will reduce the risk of cannibalising current margins, while still partaking in exploratory growth in the most promising areas. It is the authors belief that slower growth for retail through 2019 will allow management to focus on improving capacity, IP and Online segments. In the mid-term this extends support and an easing of bottle necks while improving non-core growth at a time of increasing uncertainty in retail. Particularly, gross margins and stock levels were highlighted as areas in need of improvement in the January 2019 trading update.
Furthermore, CEO Kevin Rountree has further indicated the need for continued focus on recruiting new store managers, and a number of initiatives have supported this. Ideally, managers would come from the existing user-base. The level of passion and enthusiasm for the game that is seen in former users turned managers is quite remarkable - and in the authors opinion is a key driver of the companies continued retail success (Games Workshop, 2018).
However, the retail segment adds value above and beyond the profitability of retail in isolation. As a likely first point of contact with customers, it is the retail segment that drives interest in the hobby which benefits other segments in an array of different ways. Exposure to the brand increases confidence in ordering via the online store, or exploring the catalogue of newly released digital titles for PC or console gaming (Financial Times, 2017).
Conclusion
In comparison to recent years, this is the best year yet for the retail segment of Games Workshop. With a 10-year present value of £61,780,240 for an asset that until recently performed as a cost centre for the group. This figure combined with the 10-year present value of the IP segment totals £257,645,743. To find out more about Games Workshops IP segment an additional article is currently available at A Successful Licensing Model: The Games Workshop Way.
While growth is likely to be less spectacular moving forward, there remains opportunities to explore growth across every major segment of the business. Recent growth has led to a necessary slowdown as capacity and logistics are improved for the new standard of £200m+ annual revenue.
Recruitment remains a key challenge, fortunately well understood by the management as a key area of focus. Turning current, passionate hobbyists into store managers has been leveraged within the firm for the last few decades. This stance has been further developed in recent years under Mr. Rountree.
I’ll be writing additional content on Games Workshop in upcoming reports to further explore this toy-soldiers company. To get real time updates on new articles follow me right here, on Seeking Alpha.
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