Games Workshop Group — Leviathan

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 core revenue (eight-year CAGR 18%) and operating profit including royalties (eight-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 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 GAW’s strategy is evidenced by the quoted return on capital employed (ROCE) of 133% in FY23.

On the back of a better-than-expected FY23 performance, FY24 will benefit from the launch of Leviathan, the 10th edition of Warhammer 40K. Typically, such launches have provided a strong boost to revenue and profit growth (see Exhibit 8). Our estimates of c 10% and 5% underlying revenue growth for FY24 and FY25 look conservative relative to the historical performances of previous launches. The easing of some cost pressures should help underlying margins in FY24 but GAW’s high overseas revenues (78% of core) and high UK central cost base mean revenue growth and margin progress may be hampered by recent sterling strength.

The share price has performed well during the last year as underlying trading improved and the news of a potential content deal with a subsidiary of Amazon.com was positively received. As a result, prospective P/E multiples for FY24 and FY25 of 25.1x and 24.2x, respectively, are back to being similar to more recent averages. The current 10-year bond yields and the equity market risk premium are elevated for the UK against the other major economies, which naturally hampers the valuation of GAW’s global exposure. We see good upside to our DCF-based valuation (to c £112 per share from £102 per share previously) if the company can replicate its historical success on the launches of new editions of its major properties with Leviathan (see Exhibit 11).

GAW’s financial results are influenced by 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.

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 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 revenue and EPS CAGRs 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’s 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 10th edition, Leviathan, was released in June 2023. Each edition adds new rules for playing games, refines existing ones and expands the IP of the universe in which the game is set.

The Warhammer 40K universe includes the Horus Heresy, which retells the fictional history of the 40K universe. The 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. The June 2022 re-launch appears to have been well received given the improving revenue momentum that GAW enjoyed through FY23 (see the Financials section).

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 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.

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 £40 for a set of 16 miniatures plus a 48-page introductory guide to £125 for a set of 44 miniatures plus scenery pieces, a gaming board and a rule book. A range of easy-to-build squads, which do not require glue to assemble, has been introduced, priced from £10.

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 £1,200. 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.

Trade represents 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 24% in FY15–23. The growth reflects continuous growth in the number of trade accounts including geographic expansion, and the pipeline of new releases. From an FY15 base of 3,700 accounts, GAW has added from 100 (FY16 and FY17) to a high of 800 (FY22) net new trade accounts per year, taking the number of accounts to 6,500 by the end of FY23, a CAGR of c 7%.

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 number of countries served by Trade accounts had gradually increased from 52 in FY15 to a peak of 73 in FY21, but this had reduced by one country per year to 71 at the end of FY23. The majority of account sales are made via telesales teams based in Nottingham, Barcelona (newly opened in FY23), 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 10% since FY15, Retail has grown at a slower rate than Trade and Online, albeit this includes some disruption caused by the COVID-19 pandemic from FY20. The company has subsequently surpassed the pre-COVID-19 peak revenue, c £88m in FY19, with c £106m in FY23.

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 399 of the 526 stores at the end of May 2023 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 has increased in most geographies over the long term. Prior to the pandemic, management targeted about 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 the performance of the existing stores, and the number of stores declines marginally through FY22. Following a return to net store growth in FY23, management has indicated it will open 30 new stores in FY24, the greatest number of openings since FY19, including 16 in North America (172 end-FY23); 11 in Europe (154 end-FY23) and three in Japan (16 in Asia end-FY23). A café store was opened in Tokyo in FY23, following the opening of a second café store in North America in FY21.

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 to 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 and FY20, but became a more important contributor to the group during the COVID-19 pandemic, at 25% of the core in FY21, as customers switched channels. The re-opening of economies led to Online’s contribution easing back to 20% of core revenue in FY23, but it was still more than 90% above the pre-COVID-19 levels in absolute terms.

GAW has been extremely successful in its strategy of seeking enthusiasts across the globe, such that International accounted for 78% of core revenue in FY23. 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 FY15–23, with the highest rate of growth in North America. Management believes there are significant opportunities for growth in North America and Asia. GAW continues to drive growth through 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, and is therefore 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 the company also generates revenue from board games and accessories.

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.

In December 2022, management announced that it had reached an agreement in principle with a subsidiary of Amazon.com to develop GAW’s IP into film and television and to grant associated merchandising rights, initially focused on the Warhammer 40K universe. At the time of reporting FY23 results, contract negotiations were ongoing. We have included nothing in our future estimates for any potential future revenue streams.

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 videos frequently, 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, and to 427k subscribers by the end of FY23.

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 writing, the subscription cost £5.99/month (on a rolling basis) or £49.99/year. The service enjoyed strong growth in subscribers in FY23, increasing to 136k from 105k in the prior 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 – John Brewis: John became chair on 1 January 2023, having been an independent non-executive director at GAW since 2018. He has over 30 years’ experience in high-volume manufacturing business and had various roles within Reach, formerly Trinity Mirror, including managing director of its manufacturing division.

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 as a chartered management accountant in 2001. Prior to joining Games Workshop, he was the management accountant at J Barbour & Sons.

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. Its financial results are influenced by the phasing of the release dates and relative scales of the 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.

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 overseas being warehousing in North America and Australia and the costs of GAW’s own store portfolio in other countries. Per the company’s FY23 annual report a 15% depreciation of the US dollar and euro to sterling would create income statement losses of £5.9m and £0.9m, respectively.

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 (78% of core revenue was earned outside the UK in FY23), GAW is exposed to disruption and costs of freight.

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 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. Management continues to review and consider practical and financially viable solutions to the cross-border shipping problems, and this could involve setting up a warehouse facility in Europe. In FY22, management quantified that Brexit added over £3m to its cost base, and the requirement to pre-pay VAT on the entry of goods to the EU, to be reclaimed at a later date.

Management’s strategy of growing the pipeline of new launches, increasing geographic reach to its hobbyists through more own-stores, trade accounts and increasing online distribution, and better leveraging of its IP has delivered impressive financial results since FY15. GAW has reported a core revenue CAGR of 18% and operating profit including licensing income of 34% from FY15–23.

In FY23, there was a notable step up in the year-on-year growth rate of GAW’s total revenue in the second half of the year, to c 20%, following a relatively slow start to the year with total revenue growth of c 7% in H123. This took the full year growth rate to 14%, and total revenue to c £471m from c £415m in FY22. On a constant currency basis, year-on-year revenue growth was c 8% for the full year, including no growth in H123.

There were quite divergent trends between core and licensing revenue (see below). Core revenue increased by c 9% on a constant currency basis, and again there was a notable improvement towards the end of the year following H123’s growth of 3.4%. In descending order, core’s channels grew as follows: Retail (+11% y-o-y constant currency growth), Trade (+9%) and Online (+3%).

As can be seen above, GAW benefited from the weakness of sterling versus the US dollar, specifically with an average US$1.20/£ through FY23 versus US$1.34/£ in FY22. There was also modest sterling weakness of c 3% relative to other important trading currencies such as the euro and Australian dollar, while a weaker Japanese yen would have negatively affected revenue growth.

Pricing is typically a positive for GAW’s revenue growth; in FY23 the average recommended retail price on miniatures was 6% and an average of 3% across all other product lines. These compare with average increases of 3–4% in FY18–20.

Moving into FY24, we can see from Exhibit 8 that the launch of a new edition of the major properties has typically provided a strong boost to core revenue growth and profitability. In the year of the most recent launches of the new editions of 40K, core revenue grew by c 41% (FY18) and by c 34% (FY21). We should stress that these revenue growth figures were not solely due to the release of the new editions as new editions generate revenue over multiple years, but they were certainly very helpful. FY24 and future years should benefit from the June 2023 launch of the 10th edition of 40K, Leviathan. Also, FY21’s growth was likely to have been positively affected by the recovery from the outbreak of the COVID pandemic at the end of FY20, albeit the pandemic affected the recoveries of individual countries at different times through FY21 and beyond. The most recent launch has obviously been received very well, with GAW reporting core revenue growth of c 14% to £121m from £106m in Q124, above the board’s expectations.

Against this, we would note that since the start of the FY24 financial year, sterling has strengthened against the US dollar, Australian dollar and Japanese yen by between 8–11% versus the average exchange rates in H123 and therefore would represent a headwind to GAW’s revenue and profit growth if sterling’s strength persists through the remainder of the year. For FY24 we forecast c 10% constant currency revenue growth, offset by a c 4% headwind from currency translation using year-to-date average exchange rates. The implied y-o-y revenue growth for the remaining nine months of FY24 of c 2% reflects some conservatism for growth against a tougher comparative from H223. For FY25 we forecast c 5% revenue growth.

In previous Outlook notes we have attempted to demonstrate the key drivers to changes in core’s gross margin, which has varied from c 67–73% since FY15. For FY23 management disclosed that a lower inventory provision and production efficiencies were helpful to the gross margin by a combined 170bp y-o-y, but that higher materials costs, logistics costs and new animations costs for Warhammer+ reduced core gross margin by a combined 230bp, such that the margin declined from 67.1% in FY22 to 66.5% in FY23. The easing of external cost pressures such as some input and logistics costs should be supportive of an improved core gross margin for FY24. We assume a modest increase in the core gross margin to c 68% in FY24 and FY25.

Over the long term, GAW has demonstrated high operational gearing as it has leveraged its semi-fixed operating cost base. As GAW is vertically integrated, determining profit by distribution channel is a little subjective given the necessary allocation of costs. Other factors that influence the gross and operating margin in any year include relative geographic growth rates and foreign exchange differences, the phasing of the launches of new editions of the key properties (we believe that 40K is larger than AoS) and other external operating costs pressures, such as input and freight pressures in 2022.

The core operating margin declined by 70bp y-o-y to 33.3% in FY23, mainly due to a year-on-year increase in staff costs on an absolute basis and relative to core revenue of 50bp to reward another year of strong performance and included further growth in the headcount (+4% y-o-y). Strong growth in operating profit over the long term has enabled the payments 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. We assume a modest improvement in the core operating margin to 34.6% in FY24 and 34.3% in FY25, which includes some negative leverage of operating costs from a high sterling cost base relative to overseas revenues. The strong y-o-y revenue growth in Q124 translated to a significant increase in profit before tax to c £57m from £39m in Q123, an effective margin of 45% versus 36% in Q123. If we assume a similar margin on licensing revenue (see below) as in prior periods, we estimate that total operating costs for the core business were marginally down year-on-year in Q124. This was likely due to the positive operational gearing from better-than-expected volumes and lower freight costs versus the prior year, offsetting ongoing higher staff costs from growing headcount and inflationary pressures including the flow through from the increase in the National Living Wage.

Licensing income has become an important contributor to GAW’s growth in profitability, growing from £1.5m in FY15 to an all-time high of £28m in FY22 before reducing to £25.4m in FY23, 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, leading to a variable debtor balance for licensing income. Licensing revenue fell by c 9% y-o-y in FY23 to £25.4m (FY22: £28m). The key driver of the decline was a reduction in the first-year guarantee income from multi-year contracts, which was significantly higher in FY22, £15m versus £4.3m in FY21 and £8.1m in FY23. The strength of GAW’s licensing partners is indicated by the increases in other income (ie non-minimum guarantees from £12m in FY21 to £13m in FY22 and £17.3m in FY23). The company reported a significant increase in licensing revenue in Q124 to £6m from £3m in Q123, albeit the comparative was relatively easy.

Given the limited visibility on licensing, we typically assume licensing revenue grows in line with core revenue over the long term, as a proxy for GAW leveraging its IP, given the limited visibility of the phasing and performance of the individual licence and terms. This would appear to be conservative versus the historical relative growth rates: core’s operating profit CAGR from FY15–23 of c 33% is below the c 40% CAGR for licensing operating profit over the same time frame. We compare operating profit here as licensing revenue has only been disclosed since FY21.

With a gross margin of 100% and an operating margin of c 87% in FY23 due to limited associated operating costs, licensing’s relative growth rate to the core can have an important effect on GAW’s total group reported margin.

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. Prior to FY22 the definition of truly surplus cash also required provision for six months of capital expenditure. Typically, the company announces and distributes multiple dividends in a financial year. Distributions are not made with any reference to an earnings or cash payout ratio as can be seen by the increase in total declared dividends to 415p/share in FY23 from 235p/share in FY22 and FY21. For FY24 and FY25, we assume total distributions increase to 425p/share and 435p/share, respectively. So far in FY24, GAW has declared total dividends of 195p/share (dividends of 145p/share and 50p/share), c 63% higher than cumulative dividends at the same time in FY23 of 120p/share (dividends of 90p/shares and 30p/share), indicating a strong improvement in cash generation.

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 main drivers of the higher operating cash generation (relative to revenue) have been the increase in profitability, variable investment in working capital and higher cash tax payments. Working capital was much more favourable to cash generation in FY23, representing an inflow of £18.6m versus an outflow of £35.9m in the prior year, due to lower inventory including a decline in the year-end stock provision and debtors fell year-on-year mainly due to the receipt for European prepaid VAT and a decline on royalty income receivable.

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, and subsequently amortised.

GAW has a strong balance sheet and operates with a net cash position. At the end of FY23, the net cash position excluding IFRS 16 liabilities was £90.2m, an increase from the prior year’s £71.4m. The company’s only debt is retail store and warehouse leases, £49.9m at the end of FY23.

There has been some variation in the net working capital cycle between FY15 and FY23. Stock turn (relative to COGS) slowed in most years from FY15 (4.9x) through to FY22 (3.3x) as volume growth increased, leading to higher inventory provisions in more recent years. Stock turn improved in FY23 to 5.3x. Debtor days (relative to core sales) have been more consistent over the same period, ranging from 26–32 days from FY15–23. Creditors days (relative to total expenses) have ranged from four to 50 plus days typically. In our forecasts we assume underlying working capital movements (ie debtor days, etc) are consistent with those in FY23.

We consider GAW’s valuation in three ways: a DCF-based valuation, a comparison of its prospective multiples to its quoted peer group and relative to its own history.

Our DCF-based valuation has increased to £112 per share from £102 per share previously. The increase includes the update to our forecasts and the roll forward of the valuation offset by an increase in our estimated WACC from 8% to 10%.

Our new WACC reflects the higher risk-free rate, a beta of c 1.0 and an equity risk premium of 5.9% (source: Damodaran, July 2023). We note that the UK’s 10-year bond yield is higher than the other major economies, as is the equity risk premium versus the economies in which GAW earns the majority of its revenues. For example, the equity premiums for the US and Europe are 5.0%. Our terminal growth rate of 3% is equivalent to average growth in global personal consumption since 1970 (source: World Bank)

Beyond our explicit forecast period, we assume operational gearing on incremental core revenue of 35%, which is consistent with what the company has enjoyed since FY17, taking the core operating margin in our terminal year (FY33) to c 35% from 34.3% in FY25.

The sensitivity of the valuation to changes in the WACC and terminal growth rate is as follows:

The sensitivity of the valuation to different levels of revenue growth in FY24 and FY25 is shown below.

There are no directly comparable quoted peers for GAW as its closest competitors are mainly small unquoted companies. The quoted peers we look at fall into two categories: (1) the multinational ‘mainstream’ toy and special interest/hobby companies, and (2) the global leaders in IP creation for consumption by individuals. These companies have very different revenue streams, levels of cyclicality, profit margins and investment requirements, which makes a direct comparison with GAW’s multiples complicated but does provide some context for its valuation.

For FY24 and FY25, our estimated revenue growth rates for GAW are between those expected by consensus for the medians of the two sets of peers, but its estimated profitability is significantly higher than the medians of the two peer groups, which we believe warrants a higher valuation.

Below we show GAW’s EV/core sales and P/E multiples over the long term and its prospective multiples for FY24 and FY25. For each historical year we show the high, average (multiple quoted) and low multiples. With respect to EV/sales, we use GAW’s core sales figures (ie excluding licensing revenue as these were not disclosed prior to FY21; the company used to disclose only operating income from licensing), to give a longer-term perspective of its valuation. The prospective EV/sales multiples are therefore different to those quoted in the peer table above, as the latter includes GAW’s licensing income.

The step change in the company’s valuation multiples following the significant improvements in revenue growth rates, profitability and ROCE as a result of the current management team’s strategy (the CEO was appointed in FY15) are self-evident. The prospective P/E multiples for FY24 and FY25 of 25.1x and 24.2x compare with the average since FY17 of 18.5x, and are comparable with more recent averages in the mid-20s.

The multiples for FY20, and potentially in following years, were positively influenced by the negative effects of the COVID-19 pandemic (ie the multiples include share prices and valuations from before the outbreak of the pandemic but include reported financials that were affected by the pandemic).