Games Workshop Group — Forecasts maintained for FY22 and FY23

On a constant currency basis, GAW’s revenue grew by c 6%, gross profit declined by c 2%, operating profit pre royalties declined by c 11%, and operating profit post royalties grew by c 2% in H122.

With c 78% of revenue earned overseas in FY21, the c 5% y-o-y appreciation of sterling versus the euro (from €1.11/£ to €1.17/£) and US dollar (from US$1.30/£ to US$1.37/£) in H122 negatively affected the translation of GAW’s underlying results. On a reported basis GAW’s H122 revenue grew by c 3% to £191.5m, gross profit declined by c 7% to £131.3m, operating profit pre royalties declined by c 18% to £68.4m, and profit post royalties declined by c 4% to £88.5m. With minimal interest expense (IFRS 16 interest and interest income on GAW’s net cash position) and a consistent tax charge (tax rate of 19.3%), the lower operating profit translated to a decline in fully diluted EPS of c 3% to 216.6p. We note the current exchange rates of US$1.37/£ and €1.20/£ imply less of a potential negative forex translational effect for the remainder of the financial year, specifically the US dollar.

From a product perspective, the June 2021 launch of Dominium, the third edition of Age of Sigmar, is described by management as its ‘best fantasy launch to date by a considerable margin’, and H122 revenue benefited from new models for the ninth edition of 40k, in the second year following its launch in the prior financial year. However, shipping issues have led to a delay of some new product launches, which should reverse in H222. And with respect to GAW’s media and community, the subscription service Warhammer+ has ‘got off to a great start’.

With fewer COVID-19 related operating restrictions than the prior year there was a return to growth for Retail revenue (c 17% growth at constant currency), offset by a decline for Online (7% at constant currency) against a very tough comparative. Trade revenue continued with better than average growth (c 9% at constant currency) due to strong growth in the number of net new accounts, 500 in the period, which compares favourably with recent history when 500–600 net new accounts have been added in full financial years. With a net four fewer stores by the end of the period, Retail revenue of £41.9m is c 9% below pre-COVID-19 levels (£45.8m in H120), given differing rates of recovery by geography following, and ongoing disruption from, COVID-19 related restrictions, notably Australia where stores remained closed during the period but began to re-open in December 2021. At £41.5m in H122, Online revenue is c 70% higher than reported in H120, pre COVID-19.

The key features of GAW’s profitability in H122 are the decline in gross margin from 75.5% in H121 to 68.6%, which along with growth in operating costs fed through to a reduction in the EBIT pre-royalties margin of 890bps to 35.7%, offset by the significant increase in royalty income to £20.1m (H121: £8.7m).

With respect to cost of goods sold, the previously flagged cost pressures of freight (additional £2m) and input costs (we estimate additional £3.6m), a combined £5.6m, represented a drag of 2.9 gross margin points. In addition, management continued to invest for future growth with incremental staff costs (higher pay grades and headcount) of £3.0m (1.6 margin points), new facilities £0.7m (0.4 margin points) and a higher inventory provision £2.9m (1.5 margin points). Staff numbers increased in the factories (+9%) to increase capacity and in the United States (+11%). Our March 2021 note highlighted the historical effect of the inventory provision on GAW’s gross profit. From FY15 to FY21 the provision has represented 0.3% (FY21) to 2.4% (FY20) of sales, therefore the H122 provision appears within the range of prior years.

Operating costs increased by c 9% (c 11% at constant currency) to £62.9m including c 2% growth in headcount coupled with the annual 3% pay increase, as well as a c 10% increase in the profit share and discretionary payment (to £6.9m from £6.3m in H121) to staff in recognition of their performance.

The H122 royalty income of £20.1m is significantly higher than GAW has reported in any prior full financial year – the previous peak was £16.8m in FY20 – and is testimony to the attractiveness of the intellectual property and GAW’s ability to attract new licensing partners. As indicated, this income stream is difficult to predict as it depends on the timing of new contracts, and accounting standards require the recognition of the minimum guarantee of the contract on signing.

The lower operating profit, higher working capital outflow (£28.4m versus £5.2m) and higher capital investment led to a c 39% decline in GAW’s free cash flow pre-interest to £45.2m from £73.6m in H121. The period end debtors increased by £22.9m, of which £15m is due to temporary administrative delays by the local authorities in repaying the new import VAT that is paid post Brexit by GAW as goods enter the EU. Management hopes this will normalise by the end of the current financial year, but it is dependent on the expediency of those local authorities.

The period end net cash position pre IFRS 16 increased to £88.6m from £85.2m, following the payment of dividends of £37.7m during H122. Despite the lower free cash flow generation during the period, management declared three dividends totalling 100p/share versus two dividends totalling 80p/share in H121 following the outbreak of the COVID-19 pandemic. A further dividend of 65p/share has been declared with the results announcement, taking the total for the financial year to date to 165p/share versus 140p/share at this stage 12 months ago, and 235p/share for the whole of FY21. Our dividend forecast for FY22 reduces to 220p/share (250p/share previously) to allow for potential delays in the £15m VAT refunds from the EU, while we maintain our forecast of 275p/share for FY23. These are equivalent to our estimate of truly surplus cash, calculated as the estimated closing cash position less a buffer of £50m, the estimated cash tax payment and the estimated capex spend.

Including IFRS 16 liabilities of £47.6m, the net cash position reduced to £41m.

Our PBT forecasts for FY22 (c 5% y-o-y growth to £158.2m) and FY23 (c 3% y-o-y growth to £163.5m) are broadly unchanged. However, the drivers of the forecasts have changed given the dynamics of the H122 performance (ie lower profit pre royalties and significant growth in royalty income).

For FY22, we forecast a lower gross margin (69% versus 70% previously) and 6% growth in operating costs, leading to a downgrade to operating profit pre royalties of 7% to £131.9m (from £141.8m previously) taking the margin to 34.9% versus FY21’s 38.3%. We upgrade our forecast for royalty income to £27m (from £17m previously), which implies a further £6.9m of income in H222, consistent with levels achieved in the majority of more recent six-monthly results.

For FY23, our PBT forecast of £163.5m includes a stable gross margin versus FY22, lower operating cost growth of c 2%, leading to a higher operating margin pre royalties of 36.5%, and lower royalty income of £17m as per our previous forecast.

Our DCF-based valuation increases to £134/share (£129/share previously) to reflect the improved net debt position at the end of H122, and the time value of money of our unchanged forecasts, with the same discount rate (6.5%) and terminal growth rate (2%) assumptions as included in our March 2021 update note.

At a share price of £85.50 the EV/sales multiples for FY22e and FY23e of 7.2x and 6.8x are at a premium to the long run average (since FY17) of 4.7x under the current management team, which reflects the improved long-term outlook for revenue growth and profitability, but below more recent average annual multiples, for example 8.9x in FY21. Similarly, the P/E multiples for FY22e and FY23e of 22.1x and 21.5x are at a premium to the average of 17.2x since FY17, but below more recent average multiples of 24.6x in FY20 and 26.6x in FY21.