Fantasy games and miniatures maker Games Workshop (GAW) is the definition of a business which has chunky gross margins with high and sustainable returns on capital, allowing it to re-invest its cash flow to grow in size or hand back the surplus to shareholders.

Its strategy is simple: ‘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.’

Having virtually halved in the last nine months, we believe the company’s shares have rarely looked such good value.

VALUATION MATTERS

Games Workshop shares have been drifting steadily since September 2021, after investors began rotating out of highly-rated growth companies into lowly-rated financial and commodity stocks as expectations of interest rate rises grew.

Cheap, economically-sensitive sectors such as banks and oils typically do well in stock market terms when central banks start ratcheting up rates while more expensive stocks, including those with superior long-term cash-flows, tend to do less well.

At a price of £120 nine months ago, shares in Games Workshop were trading on a multiple of more than 32 times earnings for the year to May 2021.

At today’s price they are trading on just over 15 times this year’s earnings, which makes them an outstanding bargain in our view.

LIFE AFTER LOCKDOWN

There is no doubt the company was a big winner from the restrictions imposed during the pandemic.

A generation of hobbyists with time on their hands and furlough cheques in their pockets practically competed with each other to drive up sales of Warhammer miniatures and subscriptions as they sought to entertain themselves during their confinement.

While sales of many discretionary items have since slumped as the economy has reopened, in its recent trading update for the year ended in May – which was customarily short and sweet – the firm revealed core sales would be at least 9% above last year’s record level of £353 million.

In addition, royalty revenues – which it receives from PC and console games based on its Warhammer miniatures – jumped 72% from £16 million to £28 million, and there are several more video games due to be launched this year which will generate future royalties.

SIMPLE MODEL

The firm’s business model is beautifully simple: it continually invests in making the best products on the market and making its games fun and enjoyable.

‘Our customers are global. People with our particular hobby gene, that is collecting, painting and playing with fantasy soldiers, exist all over the world. Our job is to find them.’

The more customers it can attract and retain, the more miniatures it can make and sell, and by sticking to fantasy it has unlimited scope for product innovation.

Management are laser-focused on protecting their IP (intellectual property) on the one hand and improving returns on capital for shareholders on the other.

When the company makes an investment, be it in tooling to make better models, new IT systems or new warehouses to better support its stores and stockists, it is always done with the aim of driving more volumes and improving gross margins.

The firm has no debt and doesn’t make acquisitions, so it has no goodwill on the balance sheet, just cash which it distributes to its employees as bonuses and to shareholders as and when it builds up a sizeable surplus.

EXPERT VIEWS

David Beggs, analyst at Sandford Deland – which manages the CFP SDL UK Buffettology Fund (BF0LDZ3), a big backer of Games Workshop – flagged the fact core sales in both the first and second halves of the year to May were above those during ‘peak’ lockdown.

Meanwhile, royalties are making a bigger contribution. ‘This is pure profit, with no cost of sales attached,’ notes Beggs.

The drop in price means the shares have also caught the attention of investors who had previously avoided the shares.

For Mark Wright, co-manager of the VT Momentum Diversified Income Fund (B7JTF56), at today’s price the stock ticks all the boxes in terms of valuation, growth and a solid balance sheet.

‘Having had a very good pandemic, Games Workshop was previously too expensive but the shares have de-rated along with many other growth stocks.

‘It’s a fantastic business with high gross margins, largely due to the fact that its customers consider it a hobby to assemble and paint the miniatures it manufactures’ says Wright.

‘There is unlimited scope for product innovation by virtue of the fact that Games Workshop’s miniatures and universes are fanciful and it’s all original IP.

Wright is ‘excited about what the future could bring… a TV series, film or even a theme park.

‘There are so many different growth avenues for the company.’

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