Cube Midcap Report (14 Jan 2020) – Hammering the sceptics #GAW #GFTU #BOO

Cube Midcap Report (14 Jan 2020) – Hammering the sceptics #GAW #GFTU #BOO

Good morning!

Quite a lot to look at today.

I’d also like to mention that we have published Vivek’s outlook for 2020 – an excellent article discussing economic risks and what he plans to do with his portfolio.

Vivek has a really sharp mind and if you sign up for Gold Membership, you will get to read his work while also supporting the production of these midcap articles. Thank you!

  • Games Workshop (GAW)
  • Grafton (GFTU)
  • Boohoo (BOO)
  • Elementis (ELM)

Timings: finished at 5pm.

Might look at these later in the week, if news gets quiet:

  • DFS (DFS)
  • Watkin Jones (WJG)
  • Taylor Wimpey (TW.)


Games Workshop (GAW)

  • Share price: £67.70 (+6%)
  • Market cap: £2.2 billion

Half-year Report

Please note that I have a long position in GAW.

I bought a tiny stake in this last year, on the basis that I’d been saying positive things about it for a long time and the valuation did not seem entirely unreasonable.

In the approximately two months since I bought it, it’s up a shocking 29%. And it has thrown off a dividend, too!

My position sizing was incorrect – it’s still just 1% of my portfolio. But I suppose every little helps!

What it does

Most of you will be familiar with Games Workshop, the publisher of the Warhammer universe. It owns the IP and makes and sells the figurines. Combined with the hard work of its employees, this has been a license to print money in recent years.

Sell-side analysts, and myself, have been surprised by the company’s continued growth: we thought that there was risk in the company’s product cycle, and that sales might dip in years without major product launches.

Instead, EPS has powered higher every year since 2014: from a low of 34.7p to a high of 200.8p last year. The latest forecast for the current year (FY June 2020) is 227p.

H1 results to December 2019

Today’s results exhibit tremendous sales growth and operational leverage.

This is how I would analyse the highlights table:

  • revenue +18.5% (+16% at constant currencies)
  • operating profit +37.4%

This gives operational leverage of 2x, i.e. profits growing at twice the speed of revenues.

If the company continues to grow, then I would expect operational leverage to decline – when administrative and operating costs have already been spread out over a large profit stream, it’s hard to get these huge step changes in profitability.

But that’s not an entirely bad thing. If operating profits can in some sense “stabilise”, then perhaps we could think of it as a safer company. And as a FTSE-250 component since 2018, mainstream fund managers with risk aversion should be thinking about it.

Oh, and I left something out. The numbers presented above are before the receipt of royalties. Royalties really are a license to print money:

With the help of royalties receivable, operating profit is up a massive 45%.

Since royalties in principle have no costs associated with them, they are a type of pure profit which bring none of the risks associated with operational leverage. They depend only on the prestige and popularity of what they represent – which in Warhammer’s case, is a rising star. Royalties have almost doubled, year-on-year.

But the company warns us not to assume that royalties are a dependable source of income. Under accounting rules, guaranteed royalties are recognised on the income statement when contracts are signed. The timing of this is inherently unpredictable:

 As always this income continues to be uncertain and, as we recognise guaranteed royalty income in full on signing the contract, it is even harder to predict when income will be recognised. As the first half has seen more new contracts signed than prior years, we will therefore not make any promises or forecasts on the level of future income.

Segment results

Revenues are divided into three segments: Trade, Retail and Online.

GAW is considered to be vertically integrated in the sense that it sells its own gear. But that doesn’t entirely hold true in the case of “Trade” sales.

Trade sales are in fact the largest and fastest-growing segment, up by 24% in the H1 period.


The company has a rational policy of distributing “truly surplus cash”.

It distributes this cash in a haphazard manner. Timing of recent payments:

  • 2017: March, June, July, October
  • 2018: January, March, July, November
  • 2019: January, March, May, September, November

I don’t hear too many shareholders complaining about the number and size of the dividends. It’s a sign of a company that is a little unorthodox, while still being very shareholder-oriented. No bad thing!


Games Workshop writes today that its net cash generation enabled it to spend £5.7 million in “capital projects”.

It’s interesting to me that a business with a multi-billion pound valuation feels the need to justify such a tiny amount of capex. It’s a good sign – it means that they aren’t likely to throw money at projects offering poor returns.

It’s important to remember that CEOs don’t just need to be salespeople, leaders and innovators. They also need to allocate capital where it is likely to generate a higher return. And this task may be the most important one in terms of creating positive long-term results for shareholders.

Allocating capital where it generates high returns is how companies generate the free cash flow which is ultimately the purpose of running a business for profit. Sometimes, the correct decision is to stop investing and give the money back to your shareholders. GAW has shown absolutely no reluctance to do this.

Return on Capital Employed – allocating capital where it generates a high return is how you maximise your return on capital employed (there’s a clue in the name!).

Not enough companies report their ROCE or use it as a KPI. Full marks to GAW for doing this, and they should be proud of their 111% return, up from 96% last year. Merely using this as a metric is a huge green flag for me, and getting a huge result is the cherry on top.

IFRS 16 results in £16 million of lease liabilities being recognised on the balance sheet – no big deal.

Risk management – the company highlights the critical importance of its people. I like what this says about its culture:

In our opinion the greatest risk is the same one that we repeat each year, namely, management. So long as we have the right people in the right jobs we will be fine. Problems will arise if the board allows egos and private agendas to rule. We will do our utmost to ensure that this does not happen.

My view

It’s such a breath of fresh air to read a results stament with no mention anywhere of EBITDA, adjusted earnings, etc.

In other words, there are no excuses made. There is no attempt to point us to inflated figures.

And it gets bonus points for a) speaking frankly about how it uses its cash, and b) using ROCE as a key metric.

Is the stock overvalued now? Perhaps. When I bought it in November, I thought that it was fully valued against near-term prospects, but might reward the patient investor.

It turns out that patience wasn’t needed, for anyone who just wanted some quick capital gains.

I don’t think it can be denied that pricing is now rather aggressive. Even if EPS of 300p was achieved this year (which would require continued high royalty income), the P/E multiple would still be in excess of 20x.

So I have no plans to increase my position size in GAW. But I do plan to continue studying this excellent company.


Grafton Group (GFTU)

  • Share price: 900.5p (+5%)
  • Market cap: £2.1 billion

Trading update

I’ve been visiting Chadwicks recently in search of some feature doors. This makes me feel marginally more qualified to discuss Grafton shares than I did six months ago! Chadwicks and Woodies are probably the two most well-known brands incorporated under the Grafton umbrella.

Trading was “better than anticipated” in November and December. Full-year adjusted operating profit (pre-IFRS 16) will be c. £190 million, or £202 million after taking IFRS 16 into account.

Lots of helpful numbers are given by the company: I would focus on the average daily like-for-like revenue growth in constant currency, with particular emphasis on Q4.

At a group level, this shows a decline of 1.8% in Q4, but an improvement of 1.9% for the year as a whole.

I’ve been discussing the property sector repeatedly in recent results. Everybody accepts that conditions were “subdued” last year, particularly towards the end of the year, and Grafton confirms that it has the same view.

In the UK, households continued to be very cautious about discretionary spending as uncertainty persisted during the fourth quarter and sentiment continued to weigh on demand in the merchanting market.  The weak markets of September and October continued into November and December but did not deteriorate further

Actually, after what Savills reported yesterday in terms of a post-election bounce in December, I would almost have hoped for a little bounce for Grafton, too! But I guess there is a lag between the decision to transact and the purchase of building materials.

CEO comment

While we remain cautious about the timing of any recovery in the UK merchanting market at this very early stage in the New Year, our expectations for 2020 are positive for the overall Group and we are optimistic about growth opportunities.  We are well placed to continue to successfully implement our development strategy supported by very cash generative businesses and a strong balance sheet.

My view

I maintain a positive overall impression of this group, even if it’s not the sort of thing I would typically invest in. May be worth studying in greater detail.


Boohoo (BOO)

  • Share price: 333p (+5%)
  • Market cap: £3.9 billion

Trading update

Stunning revenue growth from this online fashion retailer. I’m particularly impressed by the growth of the core boohoo brand, +42% in the final four months of the calendar year 2019.

I previously suspected that BOO was prioritising PrettyLittleThing, where the founding Kamani family has a large stake (not BOO shareholders). But the boohoo brand has outpaced PrettyLittleThing, which only managed growth of 31% over the same period! (using constant exchange rates)

Guidance is upgraded:

Group revenue growth for the financial year to 29 February 2020 is expected to be 40% to 42%, ahead of our previous guidance of 33% to 38%. We expect group adjusted EBITDA margin to be 10.0% to 10.2%, ahead of our previous guidance of around 10%. All other guidance for the current financial year and our medium term guidance to deliver sales growth of 25% per annum and 10% EBITDA margin remains unchanged.

My view

I don’t have much right to comment on this, since I’ve never participated in its success. Unlike Games Workshop, I’ve never owned a single share of Boohoo.

Revenue looks set to reach £1.2 billion, this financial year, and then £1.5 billion (at 25% growth) in FY February 2021.

EBITDA margin of 10% gives us an EBITDA of £150 million next year. Net income is forecast to be £80 million. From that number, the minority interest to PrettyLittleThing shareholders must be deducted.

The patience required to see this grow into its valuation is, and usually has been, too much for me.


Elementis (ELM)

  • Share price: 140.35p (-15%)
  • Market cap: £814 million

Trading update

This is a large chemicals company. Many years ago, it was subject to activism by Hanover (who later popped up at Regenersis, now trading as Blancco Technology Group (BLTG)). That is how I came to be familiar with the name.

Regenersis was mismanaged and was a poor quality company, in my view.

As far as Elementis goes, margins and returns have been average. Financial software puts the company’s ROCE at only around 5%.

And this update doesn’t help:

  • Trading is subdued, and adjusted operating profit for the year is expected to come in at $122 million – $124 million.

The company doesn’t say what the prior expectations were, but I can see an existing EBIT forecast of $132 million. I think that’s what the actual consensus forecast was until today’s update, implying a very poor Q4 indeed.

Cash conversion – the company is challenged by a high debt load:

In 2019, our operating cash conversion* is expected to be in line with our medium term performance objective of at least 90%. This has been driven by disciplined capital expenditure and sustainable working capital reduction. As a result, net debt for the year is anticipated to be approximately $465m, representing around 2.8x net debt to EBITDA**. 

Financial deleveraging remains a key focus. The execution of our medium term innovation, growth and efficiency priorities combined with strong cash generation will drive a clear deleveraging profile.

My view – can’t get excited about this one at all.



That’s it for today, back tomorrow with another look at midcap news!





Wordpress (5)
  • comment-avatar

    Looking forward to this one Graham:-
    Three of my holdings on your list:-

    BooHoo 🙂

    Games Workshop 🙂

    Elementis 🙁

  • comment-avatar

    Thanks Graham,

    BooHoo didn’t used to be but is now my largest holding (by some margin). Getting a bit scary to hold but scared to miss out on the continuing story (maybe that’s the so called “wall of worry”). Given that they are doing so well at building what they already have and a history of only buying, at low cost, the IP and then breathing new life into busted flushes couldn’t they find a good use for all that cash they seem to be generating? Like give a little of it to shareholders?

    Rather like Games Workshop. I only wish I’d taken the plunge when it first popped up on my radar three/four years ago instead of just over 1 year ago. Somehow it’s always seemed bizarre that a company making small table top models that you had to paint yourself could be this succesful for so long.

    Elementis – probably the less said the better. A caser of “should have taken the loss a long time ago instead of wishing and hoping”.

    • comment-avatar

      Thanks for the comments Laughton – much appreciated!

      I suppose we can take solace in the fact that a good company should remain a good company for a very long period of time. 10 years from now, if they are still doing well, the hopefully our exact entry point won’t matter too much!

      Cheers (and good luck)


  • comment-avatar

    Aww shucks – thanks for the intro!

    I was thoroughly impressed by GAW results today and added – first trade of 2020 in earnest.
    Just under 4%. Wish I had bought more the first time, started life at 1.6% of the portfolio.
    Valuation is high for sure (and higher than I am ordinarily comfortable with), but forecasts are way off – they delivered 70-80% of the full year already.
    On my more bullish outlook, I agree earnings multiple is still high, but PEG is reasonable.
    Hoping this company has a long way to go – particularly encouraged by the growth in Asia (albeit from a low base)

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