Games Workshop Group — Battling on

GAW is the global leader of, and the only quoted company providing exposure to, the rapidly growing market for tabletop miniature gaming. Its miniatures, accessories and games are set in fantasy and science fantasy settings that appeal to dedicated enthusiasts with a wide age range. It is vertically integrated, controlling every aspect of the design, manufacturing, marketing and distribution of its products globally.

The strategy has delivered strong growth in revenue (seven-year CAGR 18%) and operating profit including royalties (seven-year CAGR c 38%) with better product ranges with clear and structured price points, while increasing its use of online and social media marketing to engage with its customers. Global distribution has increased through a multi-channel network of stores, websites and more third-party sellers in more countries. The company is highly cash generative, while funding investment in fixed and working capital to support its long-term growth strategy. The impressive growth and high cash conversion have supported strong returns to shareholders. Management’s financial management is reflected in a strong balance sheet and the success of the company’s strategy is evidenced by the quoted ROCE of 118% in FY22.

Our discounted cash flow (DCF)-based valuation has reduced to £100/share (from £134/share), primarily due to an increase in our assumed WACC to 8% from 6.5% to reflect the change in bond yields, and the higher corporate tax rate from FY24 (we forecast 25% for GAW in FY24 and 18% in FY23). The share price weakness over the last 12 months has led to the P/E multiples for FY23 of 16.0x and FY24 of 16.6x retracing to below multiples seen prior to the outbreak of the COVID-19 pandemic, peak multiples of c 16–23x in FY18–19, and over 30x since FY20.

Following two years of exceptional revenue growth, which included the launches of new editions/releases of the major IPs, we forecast relatively modest revenue growth in FY23 (4%) and FY24 (5%). The latter reflects some caution on the outlook for consumer spending, and no new major edition releases. The company is experiencing the effects of economy-wide cost inflation (freight, staff costs etc) and additional amortisation/investment costs which are expected to limit margin progression in the near term; we forecast PBT growth of 2.5% and 5.5% in FY23 and FY24, respectively.

GAW’s financial results are dependent on the scheduling of new editions/releases of its core IPs. Over the long term, there is a risk the existing technology for manufacturing plastic miniatures could be replaced by 3D printers. This is a challenge for the future as the best 3D printers cannot replicate the quality and certainly not at the scale of production with which GAW manufactures its miniatures. GAW continues to invest in new infrastructure and updating older infrastructure, each of which has the potential to cause near-term disruption. The majority of GAW’s sales and purchases are transacted in sterling, US dollars and euros, and fluctuations in forex rates have the potential to affect sales and margins. National lockdowns and restrictions affect GAW’s ability to generate revenue in physical locations, but online distribution enables this demand to move between channels.

GAW is a leading international specialist designer, manufacturer and seller of miniatures, scenery, hobby materials, fiction and artwork for tabletop miniature games set in its fantasy and science fantasy worlds. The company’s key brands are Warhammer Age of Sigmar (AoS), Warhammer 40,000 (Warhammer 40K, or often simply, 40K), alongside Horus Heresy, an offshoot of 40K. It also holds the licence for The Lord of the Rings and The Hobbit tabletop battle games.

GAW’s Warhammer Hobby concept is centred on customers collecting, building and painting miniatures that can be used in games played against fellow enthusiasts, either privately or at organised events. The company has delivered strong financial returns through better product ranges with clear and structured price points, and extensive use of online and social media marketing to engage with its customers. These have made the Warhammer Hobby more accessible to a wider audience, through increasing its multi-channel distribution network of stores, websites and third-party sellers more globally.

All products are designed in-house and manufactured at the company’s manufacturing, distribution and head office facilities in Nottingham. This supplies two distribution hubs in Memphis, US, and Sydney, Australia.

GAW has a clear long-term strategy: ‘to make the best fantasy miniatures in the world, to engage and inspire our customers, and to sell our products globally at a profit. We intend to do this forever. Our decisions are focused on long-term success, not short-term gains.’ That it has achieved a revenue and EPS CAGR of 22% and 45% respectively from FY16 to FY22 and now generates more than three-quarters of its revenue outside the UK is testament to the success of the strategy. The company’s strategy has five key pillars:

GAW started out in the 1970s as three games fanatics selling handmade classic wooden games from their homes in London and, later, a chain of general games shops. In 1981, the company provided funding to help establish Citadel Miniatures, a manufacturer of metal miniatures based in Nottinghamshire, which was later fully integrated into GAW.

In 1991, Tom Kirby, who remained chairman of GAW until 2017, led a management buy-out from the remaining founder, Bryan Ansell, ahead of the company’s IPO in 1994.

In 2015, Kevin Rountree, who had been CFO in 2008 and COO in 2011, took over as CEO. Kevin and his team’s focus on customer engagement across all media, greater innovation in terms of the number, quality and speed to market of new products, more structured pricing including focusing on attracting customers with starter sets, with increased openness to fully exploring the IP’s potential as a licensed property, welcomed in a new era of success and rapid growth for GAW. This has been coincident with GAW’s enhanced distribution.

One of GAW’s greatest strengths is its control over every aspect of its brand and products, from concept and design to manufacture and distribution. The company creates miniatures, scenery, fiction, artwork and the overarching framework of rules for games to be played in two key Warhammer settings: 40K and AoS.

The Warhammer brand has been in existence for more than 30 years and is the undisputed leader for fantasy and science fantasy tabletop miniature games, with a global following of dedicated enthusiasts.

Warhammer 40K: this is one of the most popular and long-established IPs in the world and accounts for the majority of the group revenue. The setting is a mixture of futuristic science fantasy and gothic fantasy with battles taking place on a post-apocalyptic war-scape in the 41st millennium. Mankind fights for survival, aided by the superhuman Space Marines as they fend off alien monsters and other horrors. The first edition of the 40K tabletop miniature game was released by GAW in 1987 and the most recent, ninth edition, ‘Indomitus’, was released in July 2020. Each edition adds new rules for playing games, refines existing ones and expands the IP of the universe in which the game is set.

Warhammer AoS: GAW developed this unique fantasy IP to replace its Warhammer Fantasy Battle setting as its core fantasy universe. Launched in July 2015, it is set in the Mortal Realms, a series of eight magical realms interconnected by Realmgates. These are the focus of fierce battles between mighty heroes, vengeful gods and fantastical creatures. With its unique IP and dynamic, engaging game, it has proved itself to be more popular than Fantasy Battle ever was, and its appeal shows no sign of slowing. The third edition of AoS, ‘Dominion’, was launched in June 2021, three years after the launch of the second edition.

Horus Heresy: retelling the fictional history of the 40K universe, this setting has been explored as part of the New York Times best-selling novel series and developed into a tabletop miniature game. Centred around a galaxy-spanning civil war taking place 10,000 years before 40K, it puts one of GAW’s core properties, the Space Marine, front and centre. Horus Heresy is also sometimes referred to by enthusiasts as Warhammer 30K or simply 30K.

Citadel: the majority of GAW’s products are made from plastic and carry the Citadel logo. Citadel miniatures mostly need to be assembled and painted, with varying levels of skill required. Price points vary widely, depending on the size and detail of the products, of which, in store, there are over 1,000. Individual miniatures start from £12 and range up to c £100 for giant monsters and war machines. A further 2,200 miniatures are available online.

To make Warhammer more accessible, the Warhammer Studio has developed a series of starter box sets for 40K and AoS. These are priced from £32 for a set of 20 miniatures plus a 64-page introductory guide to £110 for a set of 27 miniatures plus scenery pieces, gaming board and rule book. A range of easy-to-build squads, which do not require glue to assemble, has been introduced, priced from £6.

Forge World is the division that produces resin models aimed at more experienced Warhammer hobbyists. The models are typically larger than Citadel miniatures and require more time and skill to prepare, assemble and paint. As such, the pieces command a premium price compared with the Citadel range. An individual figure might cost anywhere between £17 and £400, whereas a top-of-the-range Warlord Titan (a hulking war machine) weighing 10kg and more than half a metre tall, costs over £1,300. Forge World products are predominantly sold online via GAW’s ForgeWorld.co.uk website and from its Lenton-based Warhammer World store. It represents less than 5% of group revenue.

Other products: the company produces a range of Citadel paints, paint brushes and other modelling accessories. A starter set of paints and tools costs £27+.

The Black Library studio commissions an extensive collection of fiction novels, novellas and short stories in book and audio format in Warhammer settings that helps to widen the audience and further enrich the IP. With the cost of paperback and hardback titles broadly comparable with that of high street retailers, Black Library also commissions a range of high-value (£45+) collectors’ and limited editions.

GAW’s concept and design studios work on a continuous pipeline of new initiatives and improvements to existing product lines to expand the Warhammer worlds and cater to the evolving requirements of Warhammer hobbyists. The lead time for a new product, from concept to launch, is typically 18 months, whereas the recent launches of a new edition of one of the core Warhammer games has taken place every three years. Each new edition of 40K and AoS includes rule changes and the launch of new miniatures and accessories, which encourages existing hobbyists to update and expand their collections, as well as attracting new collectors.

GAW has an integrated multi-channel approach to selling its products internationally via three channels: Trade, Retail and Online, which in aggregate represent ‘core’ revenue. Over time, Trade and Online have grown in importance to the group, and more recently Retail has made a strong recovery following the negative effects of the COVID-19 pandemic from FY20.

Trade is sales to independent retailers (some have a retail and online presence), distributors, and Black Library, GAW’s publishing sales to the book trade. Trade has been the fastest-growing component of GAW’s revenue, achieving a CAGR of c 18% in FY15–22. The growth reflects continuous growth in the number of trade accounts including geographic expansion, and the pipeline of new releases. From a FY15 base of 3,700 accounts, GAW was adding 100–200 net new trade accounts per year through FY18, taking the number of accounts to 4,100 by the end of FY18. As GAW’s global appeal has increased, there has been a step change in the number of annual net new accounts, adding 500–800 in most years, with some disruption in FY20 (200 added) due to COVID-19, and selling through 6,200 trade accounts by the end of FY22.

Trade is a key part of GAW’s global expansion strategy, particularly in countries where it does not yet have its own store presence or where it is not currently economical to do so. The majority of account sales are made via telesales teams based in Nottingham, Memphis, Sydney, Tokyo, Shanghai, Singapore, Hong Kong and Kuala Lumpur.

Although Trade is dilutive to gross margin, as products are sold at a discount to retail price, it is less capital intensive and achieves a higher operating margin than Retail. Its growing importance has therefore been important to the progression of GAW’s operating margin.

Retail includes revenue from the company’s own stores, the visitor centre in Nottingham and other hosted events around the globe. The Warhammer World visitor centre, located at GAW’s headquarters, has become a place of pilgrimage for enthusiasts of the Warhammer Hobby.

With a CAGR of 9% since FY15, Retail has grown at a slower rate than Trade and Online, albeit this primarily reflects the disruption caused by the COVID-19 pandemic from FY20, with a strong return towards pre-pandemic levels of revenue in FY22.

GAW recruits new customers through its stores, which only stock the company’s products. A store is typically opened when the local Warhammer community is of sufficient size and a physical presence is better suited to further developing that community. Given the company’s extensive IP and product range, the stores do not offer the full range of products, only newly released products, and the appropriate core ranges. As ‘destination’ stores, these are typically located away from prime retail thoroughfares. The stores are a valuable means of engaging with new and existing customers, and emphasis is placed on recruiting genuine enthusiasts to sell the products and run a variety of free-to-attend workshops and activities in store. The stores are typically single staff, with 400 of the 518 stores at the end of May 2022 staffed by just one person.

GAW’s growth has been driven by new store openings with increased geographic coverage and a general increase in productivity of the locations, with some disruption from FY20 due to the COVID-19 pandemic.

GAW’s retail presence is increasing in most geographies. Prior to the pandemic, management targeted c 25 net new store openings per year, predominantly in North America and Germany. Openings were paused during the early stages of the pandemic as management focused on improving performance of the existing stores. Following a net reduction in store numbers, management has indicated it will open 15 stores in North America (165 end-FY22) and five in France. In addition, a café store will be opened in Tokyo, following the opening of a second café store in North America in FY21.

In FY22, Retail grew in all countries except Australia and China due to COVID-19 related closures. By the end of FY22, 92% of the store portfolio was profitable.

The company runs three websites: games-workshop.com for Citadel products plus separate sites for Forge World and Black Library, and sales of books through Audible and e-books are included here too. The main website was re-launched in April 2014, followed by the migration of forgeworld.com to the same platform in summer 2015.

GAW continues to invest in the online shopping experience and develop its sites in other languages and currencies. Every GAW retail store has a web terminal for customers to access the full range of more than 3,200 products, compared with c 1,000 items available in store.

Online has been a relatively stable proportion of GAW’s business at 18–21% of total core revenue between FY15–20, but became a more important contributor to the group during the COVID-19 pandemic as customers switched channels. Following exceptional growth of c 70% in FY21 to £87.7m, Online revenue declined by c 3%, still 64% above pre-pandemic levels.

GAW has been extremely successful in its strategy of seeking enthusiasts across the globe, such that international accounted for more than three-quarters of total sales in FY22. Although its own stores are in 23 countries, it sells in many more countries through the additional reach of its websites and trade accounts, many of which have their own international multi-channel offering.

The company delivered impressive growth across all of its main markets in FY15–22, with the highest rate of growth in North America. Management believes there are significant opportunities for growth in North America. GAW continues to drive growth via new store openings, investment in its trade sales teams, and multi-language and currency websites, alongside extensive use of social media marketing to promote the brand and new product launches.

Outside the sale of physical products above, management was historically cautious about leveraging its IP into other media due to its desire to protect the integrity of its IP (a matter of finding the right partners, formats and contractual terms) or the potentially prohibitive internal investment required to develop content in specific media, eg films or television programmes. This has changed in recent years as management has invested resources in understanding how the media and entertainment industries work, as well as investing in staff to develop new partnerships. Typically, GAW receives a percentage of the licensee’s gross profit, therefore is exposed to the success of the licensed products.

The greatest success during the past 20 years has been in video games (PC, console and mobile), which have represented the majority of royalty income, but also includes board games and accessories. By the end of FY21, GAW had 125 total licences with a quoted retail value to the licensees of £133m.

With respect to other media, GAW is regularly in discussions with potential new partners, while continuing to invest in recruiting people with media experience to accelerate the development of the business.

Towards the end of FY22, a new creative director was appointed to oversee development in entertainment and licensing.

Given the niche nature of the Warhammer Hobby, GAW engages in only targeted marketing. It does this with a dedicated in-house team that creates the majority of the marketing content. This allows for greater quality and better cost efficiencies. GAW has three dedicated filming studios with which it records and streams Warhammer TV, a channel that has attracted c 500k subscribers since its launch in 2016. The company releases more than one video per day on average, including tutorials on how to build and paint miniatures and how to play the various games. Beyond this, there is a wealth of content available online, which has been created by enthusiasts. The company has continued to develop its own Warhammer-community.com website, with over 10,000 pieces of content added during FY22. It also streams events live on interactive gaming site Twitch.

The My Warhammer account, a dashboard into the Warhammer community, was launched in FY21. In FY22 registrations grew by 140% versus the prior year.

In August 2021 GAW launched Warhammer+, an online subscription service that includes animated shows as well as gaming and painting shows. In addition to content, the service gives subscribers access to free exclusive miniatures and more features. At the time of the writing, the subscription cost £4.99/month (on a rolling basis) or £49.99/year.

The genesis of fantasy tabletop games stretches back to the phenomenal success of the role-playing game Dungeons & Dragons in the 1970s, but it was not until GAW entered the market that the popularity of tabletop miniature games really took off. Once considered a pastime for ‘geeks’, tabletop games based on strategy and luck where players control miniatures have been growing in popularity and appealing to a wider demographic. As the market leader for tabletop miniature games, this is partly attributable to GAW’s recent initiatives to improve its product ranges and engage with customers, and reflects the desire of many customers to find new ways to fill their leisure time and interact with friends in a social and often ‘analogue’ setting.

GAW does not have a direct competitor. It is a niche market player with a longstanding reputation for producing the world’s best miniatures for its globally successful Warhammer IPs. Although a number of smaller, privately owned businesses, often set up by enthusiasts, have emerged with their own brands of tabletop miniature games, GAW’s scale, expertise and accumulated, rich IP are unrivalled. Its loyal customers invest significant time and money in their collections, thus reducing the likelihood of switching to a different brand. The large, listed manufacturers, including Mattel, Tomy and Hasbro, are primarily focused on board games and other mainstream toys, but also have some presence in the fantasy arena, including tabletop, card and video games.

GAW has an impressive track record of long employee service across the organisation, and its senior management team is no exception.

Chairman – Elaine O’Donnell: Elaine became chair on 1 January 2021, having been an independent non-executive director at GAW since 2013. Elaine does not anticipate standing for re-election at the 2023 AGM.

CEO – Kevin Rountree: Kevin heads the executive management team. He has significant experience in the business, having joined as assistant group accountant in 1998. He became CFO in 2008, before assuming responsibility for GAW’s global service centres as COO in 2011 and being appointed CEO in 2015. Kevin qualified trained as a chartered management accountant in 2001. Prior to joining Games Workshop, he was the management accountant at J Barbour & Sons Limited and trained at Price Waterhouse.

CFO – Rachel Tongue: Rachel joined as group tax manager in 1996. She worked in a variety of finance roles in the company before being appointed company secretary in 2008 and group finance director in 2015. From the start of November 2020, Rachel assumed responsibility for group-wide support services and legal and compliance functions. She trained as a chartered accountant and chartered tax accountant with Arthur Andersen.

Product ranges and licensing: GAW has an extensive range of existing and new products, which it must ensure remain relevant to its customers’ evolving needs. Financial results are influenced by the phasing and relative scales of the release dates of its major properties. There is limited visibility on the rate at which the company will leverage its IP through licensing partnerships, and how successful the partnerships will be. Licensing has represented a significant driver to the group’s profitability since FY15 and a continuously growing ‘library’ of IP should enable future growth.

Technology: GAW has invested heavily in its manufacturing facilities and equipment to produce plastic miniatures. Although there is a small risk that existing processes are eventually replaced by 3D printers, this is a challenge for the long term as even the best 3D printers cannot replicate the quality and certainly not at the scale of production with which GAW manufactures its miniatures. As an expert in its field, GAW remains at the forefront of injection moulding and all other miniatures technology.

COVID-19: national lockdowns and other restrictions affect the company’s ability to generate revenue in retail locations and trade accounts, therefore the outlook for these will depend on the whether there are future lockdowns and restrictions. GAW’s trade accounts and online presence enable demand to shift across the channels.

Exchange rates: the majority of GAW’s sales and purchases are transacted in sterling, US dollars and euros, and fluctuations in exchange rates have the potential to affect headline sales and margins. The company does not hedge its exposure to foreign exchange risk. There is a mismatch between the currency exposure of GAW’s revenues and costs with the main costs in overseas being warehousing in North America and the costs of GAW’s own store portfolio in other countries.

Cost of goods: there is limited disclosure with respect to GAW’s key purchased inputs. As it is a manufacturer of plastic and resin products we believe its most significant purchased inputs are oil based, therefore it is exposed to significant changes in commodity prices. In recent years, commodity costs have not been highlighted as a significant driver of changes in margin. With a high international presence (more than three-quarters of revenue is earned outside the UK), GAW is exposed to disruption and costs of freight. Please see Exhibit 11 for our estimates of the key costs within cost of goods sold (COGS).

Infrastructure: GAW has continued to invest in its physical and technology infrastructure in recent years. The implementation of an ERP system in the UK and Continental Europe, which has been in progress for a number of years, was paused in January 2022 with indications it will recommence ‘soon’ and will likely continue for some time.

Brexit: although non-UK exposure is, in our view, highly attractive, a key risk for GAW is its ability to ship products to Continental Europe, which represents more than a quarter of total sales. Following the resolution of a trading agreement with the European Union (EU), there remains potential for disruptions/delays to the company’s ability to transport goods from the UK to the EU across all sales channels and/or for logistics costs to increase to reflect less efficient customs processes. In FY22, management quantified Brexit added over £3m to its cost base, and the requirement to prepay VAT on the entry of goods to the EU, to be reclaimed at a later date, has led to an increase in debtor balances.

Our DCF-based valuation reduces to c £100/share, from £134/share previously, due to an increase in our estimated WACC to 8% from 6.5%, and in the UK corporate tax rate to 25% from FY24, versus GAW’s FY22 effective rate of 18%.

Beyond our explicit forecast period, we assume a gradual fade down of annual revenue growth from 10%% to 5% in our terminal year. We model 35% operational gearing on core revenue (versus over 80% since FY16) to give a core EBIT margin in FY32 of 33.2% (31.6% in FY24), and licensing revenue to grow in line with core revenue. We assume the investments in working capital, tangibles, intangibles and capitalised development are consistent with historical trends, and include an outflow for the effective capex for right-of-use assets. The sensitivity of the valuation to differing assumptions is shown below.

GAW does not have a direct quoted peer. In terms of product and market, the closest comparators are mainly small unquoted companies. We compare it with companies that fall into two categories: (1) multinational ‘mainstream’ toy and special interest/hobby companies and (2) global leaders in IP creation. Although far from an exact comparison, given different revenue streams and investment requirements, it provides some context to the valuation.

GAW’s EV/sales multiple for FY23 of 5.0x is at a premium to the median multiples for both groups of peers, which can be justified by its higher profitability. GAW’s higher profitability is reflected in a deserved P/E premium to the toy/special interest companies but a discount to the IP/content peers (May ’23), perhaps due to lower forecast revenue growth. We highlight that our FY24 estimate for GAW’s net income includes the increase in the corporate tax rate to 25%.

The stated strategy of growing the pipeline of new product launches, geographic expansion of the store base, the increase in the number of trade accounts, growth in online distribution and better leveraging of its IP has delivered strong financial results since FY15.

From FY15 to FY22, the CAGRs for core revenue, operating profit before royalties and other operating income, namely royalties, were 18%, 36% and 62% respectively. Disclosure changed in FY22, and FY21 was restated, to reporting revenue, gross profit and operating profit for both core and licensing, versus the previous reporting of revenue, gross profit and operating profit for the core, and only operating income from royalties receivable on licensing.

FY22 saw the release of the third edition of AoS, ‘Dominion’. Therefore, FY22’s core year-on-year revenue growth of 9% represented an impressive performance following FY21, when the ninth edition of 40K was released, and given disruption of sales from freight delays (notably to Australia), COVID-19 related lockdowns (Australia and China), and the outbreak of war in Ukraine at the end of the period. Management is considering the company’s future position in Russia, which it states represents £4m of revenue.

With more than three-quarters of revenue earned overseas, foreign exchange changes can affect GAW’s revenue growth and profitability as the exposure is not hedged. Since FY15, currency translation has had a relatively benign effect on reported revenues in most years. In FY17, following the EU referendum, sterling depreciated versus the euro and the dollar and, in aggregate, currency translation contributed c 13% to FY17’s revenue growth. The recent weakening of sterling versus the dollar to $/£1.12 versus the average for FY22 of $/£1.34 represents a potential translational tailwind for revenue and headwind for costs in FY23.

GAW typically demonstrates a high level of gearing at the gross profit level, gross margin has ranged between a low of 67% in FY20 to a high of 72.7% in FY21. GAW’s core gross margin is influenced by changes in scale and the phasing of product releases including pricing benefits, channel mix, geographic mix including FX and sourcing costs.

A reduction in gross margin in FY22 was anticipated due to the success of the ninth edition of 40K in FY21, but as FY22 progressed a number of new cost pressures emerged. Contributors to the 5.6pp decline in gross margin were a combination of higher inventory provisions (£10.6m, 3% of sales), additional freight and carriage costs (£9.2m, 2.4% of sales) and additional staff costs for future growth (£2.5m, 0.6% of sales).

Exhibit 10 shows the phasing of major edition releases and their impact on GAW’s financial performance. Although there is no disclosure with respect to the absolute revenues of 40K and AoS, we believe 40K is larger. This is confirmed by a higher core gross margin in years in which a new edition of 40K is released than when a new edition of AoS is released. In addition, GAW’s growing scale is reflected in a higher gross margin in the year of a subsequent new edition release versus the prior release.

Below we deconstructed the constituent parts of COGS using the company’s disclosure for costs including inventory, depreciation of owned assets and amortisation, and our estimates for other costs (staff costs and other) to determine the sources of change in gross margin.

The key long-term changes on a relative basis versus core revenue were an increase in staff costs, as the number of production and warehousing staff grew more than threefold (assuming the group-wide average cost per employee), a reduction in amortisation of development costs and a modest reduction in materials costs. The net inventory provision (for ageing inventory) has increased in more recent years as inventory grew with scale and stock turn slowed (see below). ‘Other’ is the residual after reversing out the above costs from reported COGS. It includes depreciation of right-of-use assets (a ‘new’ cost in FY20 due to the introduction of IFRS 16 in the place of operating lease payments) and staff bonuses. The allocation of these costs between COGS and other operating expenses is not disclosed

As highlighted in Exhibit 9, GAW has leveraged its semi-fixed operating cost base to deliver a higher operating margin over the long term. There has undoubtedly been some benefit from the increasing importance of higher-margin Trade and Online revenues at the expense of lower-margin Retail revenue. As GAW is vertically integrated, determining profit by channel is subjective given the necessary allocation of all costs by channel.

Impressive long-term profit development has enabled the payment of a profit share and a discretionary annual bonus to staff to reward them for performance, a strong indication of the importance of staff loyalty and team culture. In aggregate, the costs have typically represented 6–8% of total operating profit (core and royalties) in most years since FY17 (ie except FY20). In absolute terms, the combined costs reduced to £9.9m in FY22 from £13.2m in FY21, and the year-on-year saving provided a boost to operating margin of 1 percentage point.

Licensing income has become an important contributor to group profitability, growing from £1.5m in FY15 to an all-time high of £28m in FY22, as management has sought to extend use of the IP. There is no visibility on future licensing income as it depends on how quickly management becomes comfortable with potential partners and their use of the IP, and in turn how successfully the partners generate revenue. IFRS 15 (Revenue from Contracts with Customers), which requires full recognition of guaranteed licensing income on signing the contract, exacerbates the lumpiness of the income. There is a mismatch between recognition of income in the income statement, and the cash received over the life of the licence, as evidenced by the growing debtors for licensing income. In FY22, guarantee (initial) income increased to £15m from £4.3m in the prior year, while additional income fell from £10.7m to £10.4m.

GAW’s dividend policy is to return ‘truly surplus cash’ to shareholders, which is defined as after a working cash buffer of three months’ worth of working capital requirement and six months’ worth of tax payments. Typically, the company announces and distributes multiple dividends in a financial period. Distributions are not made with any reference to an earnings or cash payout ratio.

Total declared dividends of 165p/share in FY23 to date compare with 65p/share in FY22, suggesting a healthy cash position despite the pressures on profitability.

Our forecast for FY23 PBT (£160.4m) is broadly unchanged; the change in disclosure with respect to licensing revenue leads to higher absolute revenue and gross profit, and we introduce our new estimates for FY24.

We forecast revenue growth of c 4% to £433m in FY23 and 5% growth to £454m in FY24, recognising a cautious outlook given the greater pressures on consumer discretionary income. Given the lack of visibility on the recognition of licensing revenue, we assume it grows in line with core revenue (ie development of its underlying IP). The launch date for the next edition of 40K has yet to be confirmed.

In the recent trading update for Q123, core revenue grew by c 8% y-o-y to £106m (Q122: £98m) and licensing revenue declined by 40% to £3m (Q122: £5m). Total revenue grew by 6% to £109m (Q122: £103m) and is equivalent to around one-quarter of our FY23 revenue forecast, albeit with a different mix. The recent depreciation of sterling versus the US dollar (North America was c 44% of revenue in FY22) has boosted total revenue growth and implies low underlying growth. With some price inflation, volume growth was likely negative, which should not be a surprise following the phasing of launches in prior years.

We assume a broadly flat gross margin for core revenue in FY23 (67.0% versus 67.1% in FY22), consistent with the lower end of recent historical margins and including extra animation costs for Warhammer+, followed by an increase to 68% in FY24 on higher revenue growth.

Our estimates for a lower gross margin and mid-single-digit growth in operating costs translates to a lower core operating margin of 31.2% (profit of £134.8m) in FY23 versus FY22’s 31.8% (profit of £131.7m). Our estimate for core PBT of c £36m (quoted PBT of £39m less the assumed 90% margin on licensing revenue of £3m) in Q123 was c 10% lower than Q122, indicating elevated, c 20%, growth in operating costs. The quoted PBT of £39m in Q123 is consistent with our FY23 forecast, albeit with a different mix between core and licensing. In addition to the previously quoted cost pressures, freight and staff costs, etc, the company is bearing higher amortisation costs and the expensing of cloud-based investment for the webstore. Our assumption of lower growth in core operating costs for the remainder of FY23 is consistent with recent reductions in prices from the peak, eg oil and freight costs, and GAW annualising higher inflationary costs as the year progresses. In FY24 we forecast operating costs to grow in line with revenue and a higher core operating margin of 31.6% (profit of £143.6m). We assume licensing income generates an operating margin of 90%, consistent with FY22’s 90.7% margin.

In aggregate, our forecasts are for c 3% growth in operating income in FY23 and 6% growth in FY24. With limited financial expenses (net cash position including lease liabilities), this translates to similar rates of growth in PBT in both years. As already highlighted, a higher UK corporate tax rate of 25%, leads to a decline in net income in FY24.

We estimate a stable dividend of 235p/share in FY23 and a minor increase to 250p/share in FY24.

Over the long term, GAW’s revenue and profit growth have produced higher operating and free cash flow generation on an absolute basis and relative to revenue, while investing in its infrastructure and product development to support long-term growth. Below, we show the main drivers of cash flows relative to core revenue.

The key drivers of higher relative operating cash generation have been the higher profitability, offset by higher working capital investment and cash tax payments.

The increased investment in working capital in FY22 includes higher inventory and an increase in the VAT debtors following Brexit as GAW pays VAT on entry of products to Europe and submits a claim for repayment.

Prior to the restatement of FY21, investment in capex and intangibles was within a range of c 8–11% of core revenue with some lumpiness in the spend depending on the phasing of upgrades to its manufacturing and warehousing capacity. GAW capitalises some costs of product design and development within intangibles. As GAW’s scale has increased, so has the value of capitalised development, to £18.6m at the end of FY22. The combined expense for design and development through the income statement and capitalised on the balance sheet has ranged between 5% and 7% of core revenue since FY15.

GAW has a strong balance sheet and operates with a net cash position. At the end of FY22, the net cash position excluding IFRS 16 liabilities was £71.4m, a slight reduction from the prior year’s £85.2m. The company’s only debt is retail store and warehouse finance leases, £48.9m at the end of FY22.

There has been some variation in the net working capital cycle between FY15 and FY22. Stock turn (relative to COGS) slowed from FY15 (4.9x) through to FY22 (3.3x) as volume growth increased, leading to higher inventory provisions in more recent years. At the end of FY22, the stock position was higher than management expected due to logistical difficulties arising from freight issues, and an overestimation of sales in GAW’s forecasting. Debtor days (relative to core sales) have been more consistent over the same period, ranging from 26–32 days from FY15–21, but with a step up in FY22 to 37 days due to the higher VAT. Creditors days (relative to total expenses) have ranged from 41–52 days typically. In our forecasts we assume underlying working capital movements (ie debtor days etc) are consistent with those in FY22.