Games Workshop Group — Core growth in H124

GAW’s H124 results demonstrated strong underlying revenue growth, which translated to good improvements in its gross and operating margins versus H123. The recovery in sterling relative to the majority of the currencies in the countries where GAW generates its revenue provided a headwind to revenue and profitability, having been an important tailwind in the prior interim period. We remind readers that there is a currency mismatch between GAW’s revenues and its cost base; 78% of its core revenue was earned overseas in FY23, but a lower proportion of its operating costs are based overseas as the majority of its design and manufacturing costs are in the UK.

On a constant currency basis, GAW’s revenue increased by c 12%, with all the growth attributable to its core business (+14%) due to the launch of the tenth edition of Warhammer 40K and other successful products. Licensing revenue, which is typically lumpy, declined by c 13%. The decline in licensing revenue was across the board, ie for the minimum guarantees of the first year of new licences and the revenues from licences that are beyond their first year of revenue generation. The strength of sterling reduced total year-on-year revenue growth by just over three percentage points in H124, whereas in H123 sterling weakness boosted GAW’s revenue by over seven percentage points.

Within core revenue, Retail and Trade produced above average growth rates of 16% at constant currency, both compounding strong growth in H123, while Online’s growth was lower at c 7% y-o-y. Trade growth was fuelled by strong growth in the number of net new accounts (+500 in the period), which took the total at the period end to 7,000. Retail was helped by like-for-like growth in the majority (81%) of the stores and the addition of nine net new stores, the second consecutive six-month period of net store growth following net reductions in stores from the end of FY20 through H123.

Core’s revenue growth in H124 was consistent with management’s expectations, which included an expected slowing from Q1 (14% y-o-y) to Q2 (8%). The strength of GAW’s IP is shown by Core’s H124 revenue of £235.6m being c 26% higher than H121’s £186.8m, the period that included the launch of the previous (ninth) edition of 40K among other new products. Comparing the relative year-on-year growth rates for the ninth and tenth editions of 40K is complicated by the effects of the outbreak of the COVID pandemic from the end of FY20, as well as the fact that GAW’s results in any period include sales from all its IPs.

Overall gross profit increased by c 17% y-o-y to £175.6m in H124 from £150.6m in H123. At constant currency, the growth was more significant, at almost 21% y-o-y. In absolute terms, all of the increase was due to the higher gross margin for core, which increased by over five percentage points to 69.4%, demonstrating the typical strong leverage (ie drop through of incremental revenue to gross profit) GAW enjoys in the year of the launches of new editions of its IPs. The year-on-year decline in licensing revenue, which has a much higher gross margin of 100% than core, dampened the overall growth in gross profit, as did currency, which negatively affected it by 4% y-o-y.

The greater year-on-year growth in Core’s operating costs (of 22%) than its reported year-on-year revenue growth of 11% meant that the leverage at the operating margin line was much lower than at the gross profit line; Core’s operating margin increased by 210bp to 35.4% from 33.3% in H123. The most significant increases in operating costs were for staff costs including licensing’s operating margin increasing back to more normal levels (over 90%), following the provision for a licensing receivable in H223.

The continuous climb in the UK corporate tax rate that has taken GAW’s effective tax rate from 18% in FY22 to 25% in H124 has contributed to lower growth in EPS than pre-tax profit.

Through H124, management declared two dividends totalling 195p/share, which represented a strong increase of 18% from the prior interim period’s three declared dividends, totalling 165p/share. The increase reflects the strength in GAW’s free cash generation (see following section). With the publication of the results, management has declared a further, third dividend for the year of 120p/share, which takes the cumulative year-to-date dividends to 315p/share from 295p/share at the same stage in FY23. Recognising the greater scale of the business, management has increased its cash buffer to £75m plus six months’ worth of future tax payments. The cash buffer is used to determine what is truly surplus cash that can be returned to shareholders. Previously the ‘working cash buffer’ was three months’ worth of working capital (c £50m) alongside six months’ worth of future tax payments.

In absolute terms, GAW’s free cash flow pre-interest increased by 23% to £88m in H124 versus H123’s £71.6m. Relative to GAW’s revenue, which grew by 9% y-o-y, its free cash generation also increased. The main contributors to the improved relative cash generation were the higher operating margin, lower cash taxes and lower capex. Working capital intensity was stable versus the prior year, but there were a number of moving parts with some differences to the movements in H123. Inventories and debtors increased, as might be expected with higher sales growth, as did trade creditors due to an increase in advance payments by trade and online customers.

The strong free cash generation meant the period-end cash position increased to c £111m, from c £90m at the end of FY23. The only debt on the balance sheet at the end of November was leases of c £49m, and therefore GAW remains in a net cash position including leases of c £63m.

The changes to our estimates for FY24 and FY25 are shown below:

Our new FY24 revenue forecast includes higher growth for core and lower growth for licensing than previously following the H124 performance, as well as updating for modest changes in exchange rates. We forecast core revenue growth of c 9% y-o-y in FY24 and a decline in licensing revenue of c 5%.

We have increased our core gross margin estimate for FY24 to 68.5% from 68% previously to account for the strong performance in H124, but our estimate for lower licensing revenue (above), which has a gross margin of 100%, and higher operating costs than previously due to greater staff costs, restrict the growth in our estimate for profit before tax.

Our DCF-based valuation increases to £117/share from £112/share previously to take account of the changes in estimates, financial position, number of shares and WACC. Our WACC has reduced to 9.3% from 10% previously due to the reduction in the UK 10-year bond yield to 3.8% and a lower UK equity market risk premium of 5.5% from 5.9% (source: Damodaran). The valuation excludes any potential upside from the content that may be produced with Amazon studios.

GAW’s prospective EV/sales multiples (core revenue only as licensing revenue was not disclosed before FY21; the company used to disclose only operating income from licensing) for FY24 and FY25 of 6.5x and 6.3x remain at a premium to the long-term average since FY17 of 4.7x but below the average multiples of more recent years of c 7–9x.

Similarly, the prospective P/E multiples of 23.3x and 22.4x are at a premium to the average multiple since FY17 of 19.1x, but in line with more recent average multiples in the low/mid-20s.