I’m not often too interested in growth stocks. But after reading two books about George Soros (Trades, Portfolio) recently, I decided to see which UK stocks Soros Fund Management might hold, and one mid-cap growth stock that this legendary investment firm holds caught my eye.
That stock is Games Workshop Group plc (LSE:GAW, Financial). As its name suggests it operates in the leisure sector, and it is the producer of the popular fantasy game Warhammer, which has a cult-like following. While I’m not personally into things like Warhammer, I did notice how HBO’s Game of Thrones as well as many other fantasy titles have captured a global audience, helping bring the fantasy genre into the mainstream.
Games Workshop’s stock price is up 24% over the last year, and its market capitalisation is 3.7 billion Pounds ($5.1 billion). It could soon be promoted from the FTSE 250 index to enter the benchmark FTSE 100 index. Cumulatively, the stock is up more than 2,000% since 2016.
The company just released its annual report for its fiscal year ended May 30, 2021. Earnings per share were up 70% compared to the previous year. Revenue (in constant currency) grew by 34%. Due to a greater proportion of fixed costs and a margin improvement, the operating profit grew to 73%. High cash generation also allowed a big dividend increase to 235 pence a share declared for this year, up from 145 pence last year.
Clearly, the company has benefitted massively from Covid-19 as more people entertained themselves at home. However, strong demand wasn’t even met given some of the supply chain problems facing global trade right now. The annual reported noted “customer demand regularly outstripping available supply” last year. That’s not necessarily a good problem to have, but it's better than having too much supply compared to too little demand. In response, the company is increasing its plastic manufacturing and paint-filling capacity.
Small changes, big results
Kevin Rountree became CEO in 2015 and immediately made some small but significant changes to the company’s brand and strategy. The original main brand Warhammer was modified to Warhammer: Age of Sigmar, and products started to cover a wider range of pricing points. Digital engagement was emphasised, resulting in the popular Warhammer Community website.
As a student of corporate strategy, I must congratulate Games Workshop on their ability to capture but also help deepen the fantasy genre and make it more beloved by a wider audience. The firm was also able to boost its own online sales smoothly last year, although its retail and wholesale performances were also strong in a difficult year for physical retailers.
The stock certainly falls into the definition of a growth stock because its forward price-earnings ratio for 2022 is 30 based on analyst estimates, but its forward PEG ratio is only 1.9, which makes it a so-called "Growth at a Reasonable Price" stock. Return on Equity was an impressive 74% in fiscal 2021, compared to the prior year's number of 59%. Market consensus sees this falling back to a return on equity of 60% by 2023.
Has it reached the saturation point?
Warhammer has been around for a long time in the UK. Indeed, I remember some of my friends playing it when I was a kid, so we might consider the UK as a fairly mature market, although growth here was strong last year. The popularity of other fantasy titles around the world suggests that games like Warhammer could see strong future growth in North America and Asia.
The company’s annual report noted:
"The new edition of the Warhammer 40,000 range, set in our unique science fiction IP, was released in July 2020 and has, by a considerable margin, been our most successful launch to date. Along with fantastic new models, the new edition introduced a step change in narrative gaming for those Warhammer hobbyists whose primary passion is bringing our worlds to life on the tabletop. Sales of subsequent new releases and existing lines have all enjoyed good levels of success since the launch."
Given that Games Workshop has a high operating leverage, growth in sales results in strong growth in earnings. As the company is largely vertically integrated from design, manufacturing and marketing, the company is able to keep its profit margins high.
The cherry on the cake is the royalty income. Licensing its intellectual property rights for third party merchandise and video games boosts earnings in a way that’s almost pure profit.
No wonder Soros Fund Management owns this stock. Its stated strategy “uses a top-down approach to analyze economic, political and social factors that affect market trends” – the fantasy genre wave which Warhammer is riding is certainly a social phenomenon not going away any time soon. As they say in trading, “the trend is your friend.”
