Games Workshop: what’s the investment case?

What is Games Workshop?

Games Workshop designs, creates and sells miniature figurines used to simulate battles in tabletop games. The company’s products are mostly based around its key brand named ‘Warhammer’ and there are several variations. Each one involves different characters, settings and rules, providing different aesthetics and gameplay:

• Warhammer: Age of Sigmar – It’s original fantasy setting
• Warhammer 40,000 – It’s most popular franchise that is based in space
• Horus Heresy – an offshoot that represents a ‘fictional history’ of the Warhammer 40,000 franchise
• Lord of the Rings (LOTR) and The Hobbit – The company also creates figurines and battlegrounds for these two major franchises under licence

The company has created a market by producing these products for enthusiastic hobbyists that buy, build, paint and play with its products.

What does Games Workshop make and where?

Games Workshop creates all of its products in Nottingham, where its factory, main warehouse facility and headquarters are based, employing over 220 people. It has total control over its products and does everything in-house. The company’s suite of products includes:

• Plastic miniature war figurines for the Warhammer and LOTR franchises, branded as ‘Citadel Miniatures’
• Resin miniature war figurines that are designed for veteran players. These are rarer than their plastic counterparts and branded as ‘Forge World’.
• It also manufactures the paint, brushes and other accessories needed to decorate the miniatures. The paint is sold under the ‘Citadel Colour’ brand.
• It also has a team that works on developing fictional stories based around Warhammer and other brands, which are published under its Black Library imprint and range from short stories to audiobooks to full-length novels.

Games Workshop has ramped up the number of new products it releases each year and has demonstrated the demand for new lines and the longevity of the products it makes. In the most recent financial year to 2 June 2019, 38% of total sales came from products that had been released within the previous 12 months with the rest made up of existing products.

Where does Games Workshop sell its products?

The company has three sales channels. The first is in its own retail stores, which account for around 34% of total sales. The second is online, where about a fifth of all orders are received. The third and largest sales channel is to other independent retailers and online shops, which have become the core driver of the business and accounted for almost half of total sales in the last financial year:

^{(Source: Games Workshop company reports. Five financial years to 2 June 2019)}

Everything is shipped from the central facility in Nottingham. It has two international supply hubs, one in Memphis, Tennessee, in the US and the other in Sydney, Australia, which send the products to its own retail stores and independent retailers around the world.

Retail stores and online

There are over 500 Games Workshop stores based in 23 countries. The company takes a lean approach to bricks-and-mortar. Eight in every ten outlets are classed as a ‘one-man stores’ that are run by a single manager with no other employees. Games Workshop constantly reviews its larger stores and if any become unprofitable it has a policy to shut them down. It has continued to relocate underperforming stores and replace unprofitable multi-man outlets with leaner one-man stores. Its strategy seems well-placed considering retail sales grew 7% in the last financial year.

^{(Source: Games Workshop annual report)}

Overall, its store network continues to grow. It is mostly opening new one-man stores and is currently expanding in North America and Germany. Its ambition is to open, on a net basis, 25 new stores by the end of the current financial year.

Importantly, Games Workshop does not regard its retail stores as a place to sell products, but to acquire customers. Its games are based on people meeting in a physical space and it believes they need to see and use its products in order to appreciate them. This is one of the reasons why most of its stores are run by passionate individuals. Customers come in and play games inside the store, meet fellow enthusiasts and learn about new products.

Therefore, these stores operate more like community hubs than sales outlets. Games Workshop deliberately limits the products that are offered in-store, only offering the newest releases and some staples for beginners. Instead, it tries to introduce customers to its products in the hope they will purchase them online. For example, the company has installed a web-store terminal in every one of its shops where customers can access the company’s full range of products, meaning most customers are shopping in-store but buying online. Online sales from in-store and the web grew 5% in the most recent financial year and Games Workshop has said it will be a 'key area of operational focus' in the current financial year.

Manufacturing, wholesale and trade

‘We make things. We are a manufacturer. Not a retailer. We do have outlets in retail locations and these stores show customers how to engage with our hobby of collecting, painting and playing with our miniatures and games. They are the front end of our manufacturing business.’ – Games Workshop.

Games Workshop does not class itself as a retailer but a manufacturer, which is justified considering most of its products are sold by third-party retailers. It uses this channel to access markets where it doesn’t have its own stores, which is another example of how the company has achieved scale with minimal costs. Games Workshop intends to always have a significant trade channel and has said it will ‘always have more independent accounts than our own stores’.

The company sold to 4700 independent retailers in the last financial year, up from just 4100 the year before. It has taken great care to cater for local markets and operates in 22 different languages. The trade business is not only the largest sales channel but the fastest growing. Sales were up 29% in the last financial year and it reported growth in all 69 countries that it operates, demonstrating strong global demand.

How has Games Workshop performed?

Games Workshop started to build momentum from the middle of 2016. Revenue grew 34%, 40% and 16% in the three financial years to 2 June 2019, while pre-tax profit increased 127%, 94% and 9.1%, respectively. The improved performance has allowed the company to reward shareholders with generous lifts to the dividend, which has nearly trebled since the 2015-2016 financial year.

Little to worry about in terms of debt and dilution

One of the biggest strengths of Games Workshop is its financial discipline. The company is willing to invest when it needs to, but it refuses to stretch itself beyond its means. It has around £30 million in cash, avoids debt and doesn’t have a history of issuing large amounts of equity and diluting shareholders, demonstrated by the significant increase in its earnings per share (EPS) in recent years. The company currently has around 32.4 million shares in issue, only 1.9% higher than it was at the end of the 2013-2014 financial year. Employees have received the shares that have been issued.

Games Workshop has the intention of doing what it does ‘forever’, hence why it feels so strongly that it has to be self-sufficient. It has said it aims to deliver a ‘good cash return every year’ and enough cash flow to invest, reward its staff and return surplus cash to shareholders. Net operating cash flow in the last financial year was nearly three times higher than three years earlier, and the dividend has reached new highs despite the company raising investment in its factories, warehousing and stores. The company’s return on capital was 100% in the most recent financial year – hugely impressive even if that did fall from 120% the year before.

The amount of control Games Workshop has over its production means it can dictate how and when it releases new products. Plus, while it will feel pressure to grow like any business, it won’t feel the heat as much because the market it serves is niche and competition is minimal, meaning it won’t scale up if it can’t afford to.

What is the outlook for Games Workshop?

The company only releases interim and annual results, so we won’t know for sure how Games Workshop has performed since early June until it releases its half-year report in January 2020. However, it has released trading statements that have said sales and profits are running ahead of the previous year.

Games Workshop has said it is aiming to deliver sales of at least £140 million in the six months to 1 December 2019, with a pre-tax profit of no less than £55 million. If delivered, that would represent an 12% year-on-year (YoY) increase in revenue and a 35% leap in profits. Assuming the improved performance translates to cash flow, shareholders may be expecting a higher interim dividend payout compared to the 61p paid in the first half of the 2018-2019 financial year.

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Games Workshop: catalysts and strengths

There are a number of other strengths that are worth highlighting, as well as catalysts that could propel Games Workshop shares higher in the coming years.

Increased production capacity and logistics

Games Workshop is in the process of upgrading its production facilities and warehouses. The company started the first phase in late 2018 and the completion of the second and final phase should be announced by the time it releases its interim results in January.

The £14 million investment has already doubled the number of plastic injection moulding machines it has available. With the project set to be complete ‘in the Autumn of 2019’, it will be in a position to reap the reward of increased capacity as it enters 2020.

The company has also just started to overhaul its warehouses, including the £10 million investment equally split between its main warehouse in Nottingham and its US site in Memphis, which should be completed sometime next year. Logistics costs currently eat around 3.7% of group revenue and Games Workshop has warned that will rise to about 5%.

Growing royalties business

The company believes its intellectual property (IP) – the fantasy worlds, characters and stories from its Warhammer franchise – is ‘among the best in the world’. The company tries to leverage this as much as it can and has a growing business that sees its licence out its IP to ‘big, value-adding partners’. 87% of its royalty income comes from computer game developers making PC Warhammer titles and 7% comes from mobile games.

Royalty income amounted to £11.4 million in the last financial year. That represents less than 5% of its total revenue but that was 19% higher than the year before and has grown from just £1.5 million in 2014-2015. The company intends to continue growing royalty income and has said it is currently focused on growing the potential of licensing out its Warhammer IP to make the most of the mobile gaming opportunity.

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New entertainment and media business

Another reason why its IP is becoming increasingly important is the company’s plans to break into the tough but potentially rewarding space of media and entertainment. Earlier this year, Games Workshop partnered with a script writer and production company to make an animated TV programme based on the Warhammer 40,000 franchise named Angels of Death. The firm has said it is still contemplating how best to distribute the content but has said ‘it might well be that Angels of Death launches on our own Warhammer TV’.

The company already creates these fantasy worlds, stories and characters for its games from scratch and publishes written content to attract audiences, so it is logical to expand this into the world of film and television. However, it is taking a tempered approach and is aware that its skills don’t lie in this area.

'While our short-term goal is to understand how the entertainment and media industry works (it appears somewhat complex and expensive), longer term we believe we can closer integrate our media efforts within our business,’ Games Workshop said earlier this year.

Stepping up engagement with its niche and loyal customer base

Games Workshop’s business is niche. The firm openly says that ‘what we make is not for everyone’. But the customers it does have are loyal and often lifelong fans of what Games Workshop has created over the last three decades.

The company is also using new digital ways to reach and engage with customers from around the world. For example, its online forum (described as the ‘cornerstone’ of its online marketing campaigns) had over 114 million page views in the last financial year, almost double that of the year before. More importantly, those views came from six million users, which was up from five million. This will only enhance customer acquisition on an international scale, and it has already demonstrated the ability to serve customers from around the world using its online sales channel. Its ‘how to play’ instructional videos also doubled in terms of views. All-in-all, its Warhammer video content was viewed over 50 million times during the most recent financial year.

It is also worth noting the company’s links to children’s organisations, including 2300 schools, the Duke of Edinburgh and a string of scout clubs, which facilitates Warhammer games among children.

The opportunity in Asia

Games Workshop has room to grow in every market it currently operates in, including in the UK. Right now, Games Workshop is chasing the opportunity in the US, where most of its competitors are based, and in Germany. However, the opportunity in Asia has only just started to be tapped and could be huge.

Sales in China jumped 67% in the last financial year and 23% across the rest of Asia, but there is a reason why the company isn’t prioritising expansion in the region. It has a better understanding of the North American and European markets and has said it ‘continues to be patient’ when it comes to China, where it has five stores in Shanghai and a newer multi-man outlet in the south of the country. One challenge is translating its products and IP into mandarin, although it has proven the flexibility of its range in other countries before. It has also set up an online store but is only immediately offering basic supplies and stuff for beginners.

Games Workshop has a great opportunity in China, and although it is being patient, investors should take comfort that the company has a scalable business model to deploy once it’s ready for a big expansion.

Games Workshop: worth a roll of the die?

The last three years has been great for Games Workshop and should be celebrated as a triumph for both British retailing and manufacturing.

This company has created imaginary worlds that has engrossed a small but significant audience – and one that is growing in every single country. The digital opportunities are substantial, and the company has shown it is able to develop a business beyond its miniature figurines, expanding its content of books and videos to please existing customers and to attract new ones. It has been financially responsible and has comfortably managed to meet its investment needs while rewarding shareholders while staying away from debt and equity. Games Workshop is a unique investment opportunity with very few competitors.

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There are still threats. Growth in the last financial year was solid, but significantly lower than the two previous years, suggesting there has been something of a slowdown, and the comparatives are getting tougher to beat each year. The international nature of its business means it is exposed to exchange rate fluctuations while Brexit could pose a problem for sourcing materials and staff or impact its exports. Plus, overhauling its facilities carries its own risks. It may be better-shielded from a wider economic downturn than other retailers or manufacturers, but ‘hobbies’ would be one of the first things to be cut from a budget if times got tough.