Games Workshop: A Bottle Rocket In Dividend Clothing

By Anders Bylund

Blood Angels Space Marines from Warhammer 40,000. Image source: Games Workshop

Games Workshop (LON: GAW) is an odd duck on the stock market. Savvy investors can use that fact to their advantage, taking advantage of a situation that will slip by less sophisticated traders unnoticed.

Stocks that straddle the fence between deep value and high growth can leave investors frustrated in the short term, as the broader market can take its time figuring out how this unique beast really works.

But that also leaves in-betweeners spring-loaded for a rapid rebound when their true value becomes broadly obvious. And in the meantime, opportunistic investors can enjoy a low entry price that also locks in very generous dividend yields.

Making a mismatch
And that’s where Games Workshop comes in.

The maker of tabletop games, the figurines used as playing pieces in these games, and intellectual property associated with these game worlds might look like an obvious growth stock. Warhammer 40K has a certain mainstream resonance, and you might have heard of its Space Marines. There are video games and long-term potential for movie rights involved, and the games generally appeal to a younger but fairly affluent crowd.

It would seem natural to pair this business with a skyrocketing stock, perhaps balanced on a precariously high valuation.­

But that’s not what the Games Workshop stock is at all.

The company’s sales have not only stagnated, but have actually fallen in recent years. Revenues in fiscal year 2015, ended on May 31 of that year, were 3.6% below 2014 levels[1]. Shares have trailed the FTSE 100 index over the last two years[2], and currently trade at a bargain-basement 13.6 times trailing earnings.

Meanwhile, the company has been pumping cash into its dividend program. Games Workshop offers a fantastic 6.8% dividend yield today.

What’s next?
So we have what at first glance looks like a natural growth stock, stuck in a bit of a business rut and behaving more like a value ticker.

At the heart of Games Workshop’s recent weakness is a revamped operating model for its chain of retail stores across Europe, which took longer than expected to start paying off.

At this point, management claims that things are indeed turning around. At constant currency rates, core sales actually grew in the second half of 2015. In the more recent half-yearly report[3] for the first half of fiscal year 2016, sales came in a bit soft but earnings and cash flows increased.

These may be signs of a sputtering restart of Games Workshop’s growth engines. Don’t forget that the company and stock actually acted like the young-skewing growth stub you’d expect, not all that long ago. This can be seen in the graph below in the period 2011–2013. Here the stock price is shown versus the FTSE 100 Index (UKX).

Games Workshop was firing on all cylinders a few years ago. When there was a recently released update to Warhammer Fantasy Battles to lean on. Licensed partners were pumping out Warhammer 40,000 video games on a regular basis, and the company even produced a computer-animated movie. Ultramarines[4] may have looked more like a high-end video game than a proper Hollywood production, but featured the voice talents of John Hurt and Terence Stamp.

But Games Workshop lost its way. Now under new management, the retail system has seen a complete overhaul, Fantasy Battles was canceled in favor of the smaller and simpler Age of Sigmar system, and the third-party partnering interest has waned in recent years.

A fully restored retail system would get the stock on its way to another surge like the one starting in 2010, provided that the company can keep producing fresh gaming products. That combination is the bedrock on which effective marketing and gamer interest can be built.

And in the meantime, I challenge you to find a savings account with interest rates to match Games Workshop’s 6.8% annual dividend returns.

I think this is a special situation, offering the best of both worlds to patient Games Workshop investors. Big dividend yields and low prices now, with the promise of strong share price returns in the not-too-distant future. And it’s all made possible by a mismatch between the brand image and the current market situation.

Disclosure: Anders Bylund does not own shares of, nor is he short, any company named above. He has no present intention to take a position, either long or short, in any company named above within the next five days. Neither does he have any present financial relationship with any company named above.

Disclaimer — Risk warning

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Sources:

[1] London Stock Exchange: http://bit.ly/1W7zvnB

[2] Google Finance: http://bit.ly/20FKIlG

[3] Games Workshop Half Yearly report: http://bit.ly/1UYGBKS

[4] Warhammer movie: http://bit.ly/1Xe50xo