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When people think of businesses with the highest margins, it’s usually the tech monopolies. But Games Workshop (OTCPK:GMWKF) has a unique business model with a very wide moat. Its operating margins are larger than Google’s (GOOG). Now that the stock is available at a steep discount, investors should strongly consider picking up some shares.
Company Background
Games Workshop’s gaming miniatures might take the trophy for richly priced products. For example, its 1.5 inch plastic figurine of the vampire Cado Ezechiar will set you back $35. You’ll also need a selection of GW paints, at $4.50 a bottle, to color it. Not cheap, but it will make an excellent leader for your Soulblight Gravelords army, which probably cost you at least $500.
Games Workshop treats its intellectual property like Disney (DIS). Cado Ezechiar is the star of his own $16.99 novel. Six licensed GW digital games (four of them on consoles) were released in the past year.
Games Workshop’s main two powerhouse franchises are “Age of Sigmar” and “Warhammer 40,000.” They are rich narratives developed over three decades. Both games are the market leaders in their segment. Based on personal observation over the years, their only serious competitor is “Star Wars: X Wing,” which is a very different type of a game.
When it comes to the sculptures, lore, and gameplay, GW products are top notch. Celebrities who are players include musician Ed Sheeran and actor Ansel Elgort. By its very nature, miniature wargaming has high network effects – you need other people to play. Building an army is quite an investment of time and money, making experimentation with other games far less likely. In equity research parlance, this means there are high switching costs that lock customers in. Indie games do exist, but most players will only consider GW products.
If a company can charge $35 for a small plastic figurine, you might be wondering how profitable it is. Games Workshop has a truly unique business with margins higher than some tech monopolies. It has a gross margin of 67.06%, while Google’s is 56.80%. With the UK pound taking a hit and GW’s stock down significantly this year, investors with cash to deploy should put Games Workshop on their buying list.
High Profit Margins
Games Workshop simply owns a business that prints money. The high profit margins show the strength of its business model. In capitalism, one of the biggest threats to the profitability of a company is competition.
The high profit margins would not have been possible without the lack of serious competition, as well as GW’s enormous pricing power and ability to charge a premium for its goods. It has allowed the company to defend its profitability over the long term.
High profit margins also confer an advantage for a business. The company is going to be better able to handle whatever happens with the economy, whether it’s inflation or higher interest rates. This will come in handy in the near future as many analysts predict turbulent times ahead.
You probably can’t imagine paying $35 for a plastic figurine; the players do always complain about GW’s latest price rise. But the fact is the product offers tremendous value. My “Warhammer” club meetings every Tuesday evening, and I see the same people hanging out. Some people don’t even really play; they paint, collect the miniatures, and keep up with the ever-changing storyline. It’s more than just a hobby – it’s a lifestyle.
Financials and Balance Sheet
Games Workshop released its annual report back in July. It had a record year, but there are some caveats. While the topline and profit increased, costs grew significantly more.
First, the highlights (at constant currency):
| 2022 | 2021 | |
| Core Revenue | 391.5 | 353.2 |
| Licensing Revenue | 27.1 | 16.3 |
| Revenue | 418.6 | 369.5 |
| Operating profit | 161.5 | 151.7 |
| Earnings per share | 391.3 | 372.7 |
Licensing Revenue
One number that jumped out at me was the licensing revenue, which increased significantly from £16.3m in 2021 to £28m in 2022. This is an increase of 66%. The Games Workshop metaverses are rich, making them excellent backgrounds for games. Some of this year’s games were well received by critics. “Total War: Warhammer 3” received an 86 on Metacritic while “Warhammer 40,000 Chaos Gate Daemonhunters” received an 81. Licensed games have a long history of just being cash grabs, so it’s good to see that GW is taking the high road by making sure its franchised games are quality. Having outstanding games will also attract mainstream gamers to their tabletop games. GW has 12 unreleased games in development. Of course, licensing revenue is pure gravy because it doesn’t cost anything to produce.
Skyrocketing Costs and Decline in Margin
Revenue increased by 12.3%, but cost of sales increased 32%. With the pandemic and inflation raging, GW is operating in a unique environment. What can investors expect in the next year?
There are numerous reasons behind the increase in costs. Input price increases were partially absorbed rather than passed on to the customer. This accounted for £8m decline in gross margin. I believe GW has the power to increase prices enough to stem the decline. I was actually surprised they absorbed the costs because GW is infamous to its fan base for large annual price increases.
Warehousing costs increased significantly by £4.0m to £20.3m, the vast majority being staff costs. There have been improvements: Customer orders that would have previously taken two weeks to fulfill now only take 24 hours. The company made an investment in larger manufacturing facilities. 2021/22 is expected to be a year of record factory output, as a third Nottingham facility was opened. Production payroll increased by 2 GBP million to 12 GBP million.
Brexit added £3.4m in additional supply change cost. My guess is that that’s not temporary because political change will likely not be reversed. And losing Russia as a market meant a sales decline of £4 m. This is marginal, but it’s possible when the war ends for this to recover.
To improve the customer experience online, the company made sizable investments. 1.9 million GBP was invested in the new web store, while 1.2 million GBP was spent in increased hosting and support costs. The new web store might partially be a one-time capital investment, but the hosting and support costs will probably be ongoing.
The sizable decline in margins is a concern, but I’m not worried. The big line items are investments in the future (warehousing and production). There are noticeable improvements in quality of service. There’s a good chance that a sizable amount could be temporary (lost Russia sales and absorption of inflation).
No Mergers and Acquisitions
Many companies have an eat-or-be-eaten strategy. Games Workshop is notable in that it states it has no intention to acquire other companies, nor dispose of any of its own. This is a big plus as it’s difficult to get mergers and acquisitions right. By passing on M&A, GW can just focus on being the best miniature gaming company in the world. Shareholders do not have to worry about an ego-driven CEO bent on building an empire.
Company-Owned Stores
GW sells a unique hobby, so it needs its own stores to promote its product. 92% of them are profitable. Games Workshop operates a number of company-owned stores that only stock GW product. Their 518 stores in 23 countries help recruit new customers and sell 23% of last year’s sales. While it’s great that the vast majority are profitable, it means that GW has a lot of fixed costs. A big downturn means they’ll have to deal with staffing adjustments and hundreds of leases in expensive downtown locations. It definitely isn’t “asset light.” I would say this is a negative but necessary aspect of the business.
Independent Retailers
55% of sales came from 6,200 independent retailers (trade accounts). Other companies (notably Apple (AAPL)) have their product available in both third-party and manufacturer-owned stores and must successfully walk a tight balancing act. Trade outlets grew significantly by 800 to 6,200.
Economic times aren’t great currently as inflation affects GW’s major markets. It’s great that many retailers are interested in carrying Warhammer product despite the hit to consumer disposable income.
Is Games Workshop a Good Buy Now?
With global markets reeling, now is the time to stock up on quality companies at a discount. As you probably already know, the UK pound is doing awful. It is at a near historical low of $1.21 GBP/USD as of this writing.
According to Statista, the overall board game industry is expected to grow by a compounded annual growth rate of 10.58% between 2022 and 2026. After the pandemic-related quarantines, people are looking to reduce their screen time and socialize in person.
My argument is quite simple: The P/E ratio for GW is 13.79, which compares with a median of 18.94 over the past 13 years. As such, it’s time to buy quality at a discount.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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