Following the appointment of Kevin Rountree as CEO in January 2015, the stated strategy has delivered strong financial results driven by the pipeline of new product launches, geographic expansion of the store base, an increase in the number of trade accounts, growth in online distribution and better leveraging of its IP.
Income statement: Revenue growth and operational gearing
From FY15 to FY20, the CAGRs for revenue, operating profit before royalties and other operating income, namely royalties, were 18%, 37% and 62% respectively. This compares very favourably with the preceding years: in FY15, GAW’s revenue of £119.1m was lower than FY09’s revenue of £125.7m, and the more recent peak of £134.6m in FY13.
With 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 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 c 5% strengthening of sterling versus the dollar to $/£1.37 represents a translational headwind for H221 and into FY22.
Exhibit 6: Revenue and EBIT (FY15–H121)
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In H121, GAW reported exceptionally strong revenue growth, due to a ‘step change’ in volumes from the launch of the ninth edition of 40K, Indomitus in July 2020, good growth across the rest of the product offer and, geographically, in North America. Revenue grew by 25.9% (26.8% at constant currency), and operating income excluding/including royalties of £83.3m/£92.0m both exceeded the total for the whole of FY20 (£73.2m/£90.0m).
Exhibit 7: Costs and margins (relative to revenue)
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FY15 |
FY16 |
FY17 |
FY18 |
FY19 |
H120 |
H220 |
FY20 |
H121 |
COGS |
31.0% |
31.7% |
27.6% |
29.0% |
32.5% |
30.5% |
36.1% |
33.0% |
24.5% |
Gross margin |
69.0% |
68.3% |
72.4% |
71.0% |
67.5% |
69.5% |
63.9% |
67.0% |
75.5% |
Gross margin gearing (on revenue change) |
105% |
142% |
84% |
68% |
46% |
83% |
119% |
56% |
99% |
Total operating costs |
56.4% |
59.0% |
52.9% |
41.7% |
40.3% |
36.8% |
43.6% |
39.8% |
30.9% |
EBIT (excl. royalties) |
12.5% |
9.2% |
19.5% |
29.2% |
27.2% |
32.7% |
20.4% |
27.1% |
44.6% |
Operational gearing (on revenue change) |
10% |
378% |
50% |
54% |
15% |
57% |
98% |
26% |
91% |
Other operating income (royalties) |
1.3% |
5.0% |
4.7% |
4.3% |
4.4% |
7.2% |
5.1% |
6.2% |
4.7% |
EBIT (incl. royalties) |
13.8% |
14.3% |
24.2% |
33.6% |
31.6% |
39.9% |
25.4% |
33.4% |
49.3% |
Source: Company accounts, Edison Investment Research.
GAW’s revenue growth led to significant operational gearing as the operating margin ex-royalties increased from 12.5% in FY15 to 27.1% in FY20 and 44.6% in H121. The improved margin arose from leveraging the semi-fixed operating costs which fell from 56.4% of revenue in FY15 to 30.9% in H121, while the gross margin has been more variable.
Gross margin: High level of gearing to revenue changes
GAW typically demonstrates a high level of gearing at the gross margin level. H121’s revenue growth of 25.9% produced a very impressive gross margin increase of c 6pp y-o-y to 75.5%. Gross margin gearing was 99%, namely for every £100 of incremental revenue, £99 fell through to gross profit. As might be expected given the manufacturing base, gross margin gearing works in both directions: in FY15, FY16 and H220 (due to COVID), lower revenue versus the prior period was accompanied by lower gross profit.
GAW’s gross margin is influenced by changes in scale, the phasing of product releases including pricing benefits, channel mix, geographic mix including FX and sourcing costs.
Exhibit 8 shows the phasing of major product releases and GAW’s financial performance.
Exhibit 8: Phasing of new editions
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FY15 |
FY16 |
FY17 |
H118 |
H218 |
FY18 |
H119 |
H219 |
FY19 |
H120 |
H220 |
FY20 |
H121 |
Product launch |
40K (7th) |
Sigmar (1st) |
|
40K (8th) |
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|
Sigmar (2nd) |
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|
|
|
40K (9th) |
Date of launch |
May 2014 |
July 2015 |
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June 2017 |
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|
June 2018 |
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|
July 2020 |
Revenue growth y-o-y |
(3.5%) |
(0.9%) |
33.9% |
54.5% |
28.2% |
40.0% |
14.3% |
17.6% |
15.9% |
18.5% |
(7.6%) |
5.1% |
25.9% |
Gross margin |
69.0% |
68.3% |
72.4% |
72.1% |
69.9% |
71.0% |
66.9% |
68.1% |
67.5% |
69.5% |
63.9% |
67.0% |
75.5% |
Gross margin change y-o-y |
|
(0.7%) |
4.1% |
2.2% |
(4.5%) |
(1.4%) |
(5.1%) |
(1.8%) |
(3.5%) |
2.5% |
(4.2%) |
(0.6%) |
6.1% |
The most recent annual peak in gross margin was 72.4% in FY17 before it reduced over the next three financial years. FY18 and FY19 were negatively affected by the use of third-party warehousing to accommodate higher volumes, and FY20 reflects the COVID outbreak in H220. The peak annual gross margin in FY17 was prior to the launch of the eighth edition of 40K. The intra-year margins show a higher gross margin on launch, due to the initial volumes of the release, which then reduces after volumes peak, and the inventory provision is made at the year-end. For example, the gross margin in H118 was 2.2pp higher than the 69.9% reported in the following six months. The lower gross margin in H119 on the release of the second edition of Age of Sigmar reflects, in part, the strong comparative of the more popular 40K release. The higher gross margin of 75.5% in H121, on the launch of the ninth edition of 40K, is consistent with the results of prior launches, albeit gearing was significantly higher than historically, therefore a lower gross margin into H221 is likely.
The mix of revenue from new products has increased from 30% of revenue in FY16 to 38% in recent years, and therefore the annual impact of average annual price increases (typically 3–4%) on newer products is likely to have been beneficial to gross margin.
Exhibit 9: Revenue mix and gross margin
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Exhibit 10: Revenue mix and operating margin
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Source: Company accounts, Edison Investment Research
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Source: Company accounts, Edison Investment Research
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Exhibit 9: Revenue mix and gross margin
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Source: Company accounts, Edison Investment Research
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Exhibit 10: Revenue mix and operating margin
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Source: Company accounts, Edison Investment Research
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Exhibit 9 shows there is not a consistent direct relationship between channel mix changes and reported group gross margin, as other factors highlighted above also influence the margin. Until FY20, Online revenue, with a higher gross margin, was a relatively consistent percentage (18–21%) of group revenue. Trade has a lower gross margin due to its wholesale nature and has constantly grown in importance to the group at the expense of higher-margin Retail. In H121, the significant increase in Online coincident with the 40K release proved to be very beneficial to gross margin.
We have 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.
Exhibit 11: Constituents of COGS (relative to revenue)
|
FY15 |
FY16 |
FY17 |
FY18 |
FY19 |
FY20 |
Cost of inventory |
15.4% |
15.2% |
15.8% |
13.0% |
15.4% |
14.5% |
Net inventory position |
1.0% |
1.5% |
0.9% |
1.8% |
2.2% |
2.4% |
Staff costs |
3.2% |
3.5% |
3.5% |
5.8% |
6.3% |
6.2% |
Depreciation |
2.5% |
2.7% |
2.4% |
1.8% |
2.1% |
2.3% |
Amortisation |
4.2% |
3.3% |
1.9% |
2.0% |
2.2% |
1.9% |
Other |
4.7% |
5.4% |
3.1% |
4.7% |
4.2% |
5.8% |
Total COGS |
31.0% |
31.7% |
27.6% |
29.0% |
32.5% |
33.0% |
Source: Company accounts, Edison Investment Research
The key long-term changes on a relative basis versus 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) increased relatively consistently as the company’s inventory grew with scale and stock turn slowed (see below). ‘Other’ is the residual after reversing out the above costs from reported cost of goods sold. 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.
Operating profit: High operational gearing
As highlighted above, GAW has leveraged its semi-fixed operating cost base to deliver operating margin gains. Broadly, Exhibit 10 shows the increasing importance of higher-margin Trade and Online revenues at the expense of lower-margin Retail have been positive for the group’s operating margin. We believe all channels have increased profitability over time. As GAW is vertically integrated, determining profit by channel is complicated by the not being able to identify costs by channel. The company’s disclosure of the sources of operating profit changed in FY20, since which time the disclosed operating profit of the main functions is determined by benchmarking versus peers. Therefore, the disclosure is of limited use in tracking/modelling profitability of the different channels.
The breakdown of the main operating costs, namely their scale and how they change, provides some insight into how profitability has changed. The main line items in total operating costs of £104.5m in FY20 were Retail £55.6m (53% of total), Operations and support £26.5m (25%), Trade £9.3m (9%), and Online £5.5m (5%). In H121, GAW’s operating expenses increased by 6% y-o-y versus revenue growth of c 26%. Cost reductions for Retail (-14% y-o-y), Operations and support (-5%) were partially offset by increases for Online (+33%) and Trade (+4%). Therefore, the operating costs of Trade (+4%) and Online (+33%) increased more slowly than their respective revenue growth rates of 33% and 88%, but the reduction in Retail’s operating costs (-14%) was lower than its revenue decline of 19%.
Impressive long-term profit development has enabled the payment of a profit share and discretionary annual bonus at a combined cost of c £5m in recent years. The latter was not paid in FY20 due to the effects of COVID, but was reinstated in H121 at a cost of £5m, 2.7 margin points.
Royalties: Leveraging its IP
Licensing income has become an important contributor to group profitability, growing from £1.5m in FY15 to £16.8m in FY20, 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. In H121, royalty income of £8.7m declined by c 23% y-o-y against a tough comparative. Within the £8.7m, guaranteed (initial) income declined y-o-y by 63% to £2.3m, but additional royalty income above the initial guarantee levels increased by 42% to £6.4m. The latter is a good indicator of management’s success at finding the right partners.
Dividends: Strong returns for shareholders
GAW’s dividend policy is to return ‘truly surplus cash’ to shareholders. Distributions are not made with any reference to an earnings or cash payout ratio, but we include them below to show how they have developed. Typically, the company announces and distributes multiple dividends in a financial period.
Exhibit 12: Dividend progression
|
FY15 |
FY16 |
FY17 |
FY18 |
FY19 |
FY20 |
CAGR |
EPS (p) |
38.1 |
42.0 |
94.5 |
181.6 |
200.8 |
217.8 |
42% |
DPS (p) |
52.0 |
40.0 |
74.0 |
126.0 |
155.0 |
145.0 |
23% |
Earnings cover (x) |
0.7 |
1.0 |
1.3 |
1.4 |
1.3 |
1.5 |
|
FCF per share (p) |
34.5 |
36.2 |
96.3 |
148.1 |
152.8 |
244.4 |
48% |
Dividend cash cover (x) |
0.7 |
0.9 |
1.3 |
1.2 |
1.0 |
1.7 |
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Source: Company accounts, Edison Investment Research
As well as providing spectacular share price returns in recent years, the CAGR for the total annual dividend was 23% since FY15, lower than the growth in free cash flow per share and EPS, as cover for both has increased. In H121, GAW declared two dividends totalling 80p/share, and after the period end declared a further dividend of 60p/share, compared to three dividends totalling 100p/share in the prior interim period. In the Q321 trading statement, management declared a further dividend of 45p/share taking the total for the year to 185p. We assume a total dividend of 200p per share in FY21, y-o-y growth of 38% and further growth of 10% to 220p in FY22. These would represent cash costs of £65.5m and £72.2m versus our forecasts of FCF of £91.1m and £126.8m.
Forecasts: Growth to continue in FY21 and FY22
Our forecasts for FY21 and FY22 are relatively unchanged, despite the inclusion of a minor foreign exchange headwind of c 3% in FY22. This mainly reflects the recent strength of sterling versus the dollar to U$/£1.39, c 7% stronger than the year to date average of U$/£1.30.
We forecast y-o-y revenue growth of c 30% in FY21 to £349.1m and further growth of c 9% in FY22 to £381.4m. The former implies y-o-y revenue growth of c 34% in H221, versus growth of 26% in the interim period. It reflects continuing strong sales growth from 40K and the easier comparative from H220 when most operations ceased trading from the end of March to at least the start of May. We assume continued growth for Trade (+33%) and Online (76%) and a marginal decline for Retail. The forecast for H221 implies lower average monthly revenue of £27.1m than H121’s £31.1m, bur more than H220’s £20.2m.
For FY21, we forecast a gross margin of 72.5%, gearing of c 90% on incremental revenue and lower gearing (c 80%) in FY22 to reach a gross margin of 73.3%. The gross margin for H221 of c 69% is c 650bp lower than H121’s 75.5%, reflecting the typical lower gross margin in the second half of the year of a major product release, and an increase in logistics following Brexit.
With the release of the H121 results, management announced that it is in the process of cancelling the UK expanded business rates retail discount scheme for 2020/21, which has been completed. GAW had already repaid other financial assistance received from governments, eg for furloughed staff, during lockdown in H121.
Further down the P&L, our assumptions are unchanged except for a modest change in net interest due to higher interest on lease expenses following the increase in the lease liability at the interims.
Our forecast for FY21 EBIT pre-royalty income of £128.1m represents y-o-y growth of 75% and a margin of 36.7% (FY20: 27.1%). We assume operating cost growth of c 27% in the second half of the year due to increased headcount and associated costs as well as higher marketing costs. It follows cost growth of just 6% in H121, including the reinstated discretionary staff bonus of £5m.