Why I’m bullish on this turnaround stock

Shares in struggling toy maker Hornby (LSE: HRN) are charging higher this morning after the company reported that its turnaround plan is finally gaining traction. 

Hornby notified its shareholders today that the group expects to meet its full-year forecasts as its multi-year restructuring programme remains on track. However, while the company is confident that it will meet full-year City expectations, management is also warning that the group will continue to be lossmaking while it progresses through its “transition.” 

And the City forecasts it expects to meet are hardly anything to get excited about. Analysts have pencilled-in a pre-tax loss of £6.3m for the year ending 31 March and earnings per share of minus 5.9p. Hornby’s management expects revenue to decline by 20%-25% year-on-year. According to today’s trading update, group revenue was down 25% over the Christmas period, with UK revenue falling 21% due to the move by the group to slim its product range and exit concession arrangements in the UK.

Still, despite falling revenues, I believe Hornby’s turnaround has now taken hold, and over the next 12 months, the company will be able to prove to its investors that it’s back on track. 

A different business

Hornby will never be the toy giant it once was. The world has changed considerably since it dominated the toy scene and it’s highly unlikely toy tastes will change back to the way they were any time soon. Nonetheless, there’s still demand for Hornby’s products, albeit from a smaller base. 

Over the past few years, Hornby has been struggling to adapt to the new trading environment, but it now looks as if the company has found its feet. By lowering its cost base and focusing on a smaller audience, Hornby might be able to replicate the same success as Games Workshop, which is focused on its die-hard hobby fans who are willing to pay more for less.  As a result, Games Workshop is a cash cow. The shares yield 6.2% and have gained 60% in the past 12 months. 

A different model 

Hornby’s peer, Character (LSE: CCT) has been able to succeed where Hornby has failed thanks to innovation. New toy lines have helped the group expand revenue 20% over the past year and City analysts are expecting the company to report pre-tax profit growth of 25% over the next two years. But it doesn’t look as if the market is convinced Character can keep this growth up. Shares in the company currently trade at an undemanding forward P/E of 10.6 and yield 3.2%. 

As Hornby’s toys are relatively niche compared to Character’s multiple toy lines, it’s not likely the company will ever be able to replicate Character’s success. However, if the firm concentrates on its most important, and profitable customers, I believe it can return to profitability and generate lucrative returns for investors.  

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.