QUALIPORT
Niche Company Winners

By Maynard Paton (TMFMayn)
November 10, 2003

"Niches have some wonderful natural advantages. They are largely protected from macro economic factors, their customers are dedicated and loyal, and price isn't the number one consideration." -- Tom Kirby, chairman of Games Workshop (LSE: GAW).

They're small, obscure and sell products that cater for a very limited audience. However, the advantages Tom Kirby describes frequently provide leading 'niche' companies with a sustainable competitive advantage, which every buy and hold share investment ought to possess.

Shareholder returns from businesses that dominate a sector niche can be very healthy. For example, the shares of Games Workshop, the world leader in tabletop battle games, have surged seven-fold in the past three years. Over the same time, Hornby (LSE: HRN), the firm behind the famous model trains, has seen its shares soar nine-fold. Toy soldiers and train sets may not excite everyone, but those who do get excited generally head straight to those two companies.

Hard times

Admittedly, niche multi-baggers don't come easy. Both Games Workshop and Hornby fell on hard times around 2000, a time when many commentators were happy to give the last rites to old-fashioned toys. But new management were soon on top of things and, following corporate restructures, profit recoveries promptly followed.

Importantly for investors, Games Workshop and Hornby maintained their prominent brands and reputations -- i.e. their competitive advantages -- throughout the difficulties. A revival therefore was all the more probable, with profits at Games Workshop having subsequently doubled and earnings at Hornby up four-fold.

Also supporting the substantial share price gains were bargain valuations. Games Workshop once traded on a price to earnings (P/E) ratio of 5 and offered a 10% dividend yield, while Hornby at one point came with a near-8% yield with half its market value represented by cash in the bank. The low ratings were probably due to the shares being well below the institutional radar. At their 2000 lows, Games Workshop had a £30m market value, while Hornby was worth under £10m.

So, where are the niche company winners of tomorrow? Though neither are substitutes for large companies with obvious franchises, these two companies could well make for profitable side bets in a buy and hold portfolio.

First class

Stanley Gibbons (LSE: SGI) is certainly a niche leader. Just like playing with toy soldiers and model trains, stamp collecting is also considered an activity pursued by those who should 'get out more'. But who cares? Some people enjoy stamps and dealers and collectors alike make money. In fact, the Stanley Gibbons index of 100 leading stamps is up 45% since 1997.

Stanley Gibbons has many similarities with Games Workshop and Hornby. It too is the oldest and biggest name in its field, is supported by a loyal bunch of aficionados and has suffered a few lean years of late. But the stamp firm is set for a recovery and the shares appear cheap.

If you believe the 70% earnings growth forecasts for this year and next, the P/E for 2004 is around 6. Stanley Gibbons is only worth £9m at today's 36p share price but, with its leading philately brand still intact, has all the signs of becoming a first class niche investment. Read more.

Grease monkeys

Mending cars is slightly more macho than collecting stamps, but it's still an activity practiced by the few who don't mind getting dirty under a bonnet. Amateur mechanics could not do without their Haynes manuals though, to which they should thank Haynes Publishing (LSE: HYNS).

Haynes is the worldwide market leader in the production and sale of car and motorbike repair manuals. Even so, shareholders watched on as profits tumbled between 1999 and 2001. But a boardroom re-jig steered the company back on track and, such has been the turnaround, the dividend was lifted 86% in 2003. Similar to Games Workshop et al, Haynes never really lost its pre-eminent niche position during the difficulties.

A cursory inspection of Haynes' latest annual report reveals many attractions, notably operating margins of 21% and a relative lack of tangible fixed assets. A 314p share price values Haynes at £23m and presents a forward P/E of below 10. Tempting.

Trading update

Following Thursday's announcement, Friday morning saw the Qualiport (notionally) sell 259 Carpetright (LSE: CPR) shares and purchase 683 London Stock Exchange (LSE: LSE) shares. Read more.

More: Games Workshop | Hornby | Stanley Gibbons | Haynes | FREE Annual Reports

The author owns shares in Carpetright, Games Workshop and London Stock Exchange.