The fantasy wargames specialist is back in the black, thanks to cost-cutting and surging royalties.
A perk of being a director at Games Workshop (LSE: GAW), the creator and retailer of the Warhammer fantasy tabletop wargames, is surely that you have a ready answer for anyone who asks: "You and whose army?" in the form of thousands of tiny orcs, goblins and elves.
More usefully for investors, Games Workshop is also reconnecting with its army of hobbyist fans.
Today's results beat even the upgraded expectations that followed June's trading statement. Full-year revenue for the year ended 31 May was £126m, up 14%, while pretax profits were £7.5m compared to 2008's £1m. After tax, diluted earnings per share came in at 17.4p, compared to a loss of 2.4p.
True, growth was helped by sterling weakness, which offset poor sales in continental Europe; currency moves accounted for around £0.5m of the profits before royalty income, or almost 10%. Meanwhile, those royalties payments doubled to £3.5m, massively improving profits and cashflow.
Rather than using this cash to reinstate the dividend it axed last year however, the company has massively reduced its debt, from over £10m to just £1.6m.
Given uncertainty around royalty income, I think that's wise. Such income made up 39% of operating profits, but the otherwise very clear final results barely referred to it.
Instead, CEO Mark Wells concentrates on the underlying improvements to Games Workshop's vastly bigger core business, saying he sees good potential to grow profits further.
Revamping retail
Games Workshop has always stressed the importance of its High Street stores (or 'hobby centres') in showcasing its brands.
There was a net increase of 21 such stores to 355 worldwide in the past 12 months, up from 324, but those figures hide a lot of shuffling.
In North America, Games Workshop has been closing stores in malls where the opening hours don't suit it, and where costs are higher. Strip mall stores are cheaper, and presumably enable its hobby centres to open late or at weekends to host impromptu games for fans.
Games Workshop has also successfully trialled a one-man store format, which it says will enable it to put smaller hobby centres in even more towns.
The company has tweaked staff hours, closed or moved some local offices, and introduced new performance related terms for store managers. Salaries and related expenses are Games Workshop's biggest expense at over £50m. (It's worth noting £350,000 a year goes to chairman and major shareholder Tom Kirby -- more than CEO Mark Wells' £250,000).
Less impressive is the online operation. The report boasts it's revamped and rolled-out a new website successfully, but I think the site is somewhat confusing, and hides the products for sale. Direct sales actually fell from 12% to 11% as a percentage of income in the past year; disappointing in our online era, especially given the lower overheads.
Plastic fantastic
A further big cost for Games Workshop is the metal used to make its miniatures. This also adds a lot of risk to the business, especially when commodity prices soar quickly like last year. The company is therefore moving its models -- and its fans -- to a plastic range.
Previously, the plastic models seemed to be pitched as a cheaper, bulk option for consumers. But Games Workshop has now invested in new tooling facilities in Nottingham, and claims its latest plastic models are superior to their metal equivalents.
Accordingly, it's putting up prices of the plastic line-up. Given they cost less to make, this bodes well for profits -- provided consumers accept the transition. It also reduces exposure to the wilder commodity swings, though the company will still be affected by oil and energy prices, of course.
Mysterious royalties
As mentioned, the other significant development is the £3.5m Games Workshop received in royalties last year, on which the annual report provides no real information.
The increase from £1.7m last year coincided with the release of Electronic Arts' licensed online game, Warhammer: Age of Reckoning (WAR) in September. However, that could have triggered pre-release royalty payments in 2008 to Games Workshop, too.
Presumably GAW is paid royalties as a percentage of sales; however, we don't know, and there may be sort of flat annual fee component.
In terms of sales, after a promising start with one million subscriptions, WAR interest has waned, due to bugs and resurgent competition from rival World of Warcraft. Reports suggest WAR now has only about 300,000 monthly subscribers -- healthy online games need to grow, not shrink, to attract more gamers.
Pricey dice
The shares rose strongly this morning, after a big run-up in recent months. As I write they're 334p, putting Games Workshop on an expensive-looking P/E of 19.
Analysts forecast that sales will rise further in 2010, but given the uncertainty of those royalties, that seems risky. There are 31.1m shares in issue. If we strip out the £3.5m royalty income, we get earnings per share of around 10p, or a P/E of over 30!
Discounting royalties entirely is surely too harsh, but it reveals the risks to Games Workshop's earnings. Anyone who followed the shares back in the booming but short-lived Lord of the Rings era will take non-core income with a pinch of salt -- just as the directors seem to be doing.
I like Games Workshop's strategy, and its return to profit is especially impressive in this climate. The directors own over two million shares -- the vast bulk held by chairman and former CEO Tom Kirby. Another positive.
But given the uncertain outlook, its shares are just too highly rated. If Games Workshop really is firing on all cylinders again (and if the royalty income holds or grows) that P/E will come down. But personally, I would wait for some slack in the share price before investing.
More share ideas from Owain Bennallack:
