Cube Midcap Report (30 July 2019) – GAW, GRG, JUP, SBRE

Cube Midcap Report (30 July 2019) – GAW, GRG, JUP, SBRE

Good morning, it’s Roland here with today’s Midcap report.

The companies I’m aiming to look at today are:

Games Workshop (GAW)

  • Share price: 4,736p (+1%)
  • Market cap: £1.5bn

Full-year results

This fantasy war gaming company needs no introduction and has been a terrific success in recent years. Customers buy characters such as Inquisitor Lord Hector Rex (pictured above) as unpainted plastic kits and paint them to take part in Warhammer games.

In today’s 2018/19 results, chief executive Kevin Rountree says that “we believe our customers carry our Hobby gene”. I don’t have this gene myself, but I still admire this well-run and extremely profitable business.

Let’s take a closer look.

Record profits: Mr Rountree set the tone for today’s results with a remark that could have come straight out of one of Warren Buffett’s shareholder letters:

GAW FY19 Kevin Rountree comment

The firm’s results for the year to 2 June certainly seem to support this ambition:

GAW FY19 results summary

These numbers show that sales rose by 15% at constant currency last year, while operating profit climbed 9% to £81.2m. As profits rose more slowly than sales, we can assume that margins fell.

My sums indicate that GAW’s operating margin last year was 31.7% at constant currency, compared to 33.6% the previous year. Similarly, return on capital employed fell from 83% to 75% last year. Given the continued growth in sales and profits, I don’t see this fall in profitability as a concern.

Indeed, I can’t find anything to concern me in these figures.

The firm ended the year with net cash of £29m on the balance sheet and no debt. After-tax profit of £65.8m was backed by free cash flow of £50.1m. This figure is an almost exact match for dividends paid during the period of £50.3m. This reflects the company’s admirable policy of returning “truly surplus cash” to shareholders.

Television ventures: The company is starting to try and monetise its 30-year archive of stories and characters. Earlier this month, the company signed a development agreement with a TV production company for a Warhammer 40,000 story.

The company has also begun production on an animated series, Angels of Death, which is also based on Warhammer 40,000.

These are new areas of revenue generation and it’s not yet clear how valuable the firm’s IP will prove to be. But to me, this seems a sensible add-on activity. It should also be a good way to attract new fans and customers.

My view: Games Workshop’s financial results are impeccable and I admire Mr Rountree’s skilled stewardship of this business.

Today’s results have left the stock trading at about 23 times FY20 forecast earnings, with a dividend yield of about 3.2%.

Although I’d consider the shares to be fully priced at current levels, the group’s strong profitability suggests to me that this valuation should be supportable. Further gains seem possible if last year’s performance can be maintained.

I don’t have any insight into whether this business will still be around in another 30 years. But as things stand today, I can’t see any reason to dislike these shares.

Greggs (GRG)

  • Share price: 2,342p (-2%)
  • Market cap: £2.4bn

Interim results

Like Games Workshop, food-to-go retailer Greggs seems unable to do much wrong at the moment. Having said that, the shares are down by 2% at the time of writing despite the firm reporting half-year sales up by 15% to £546m. So what’s going on?

“Exceptional trading”: Sales during the first half of the year continued to growth strongly, with total sales up 14.7% to £546m. Like-for-like sales in company-managed shops rose by an impressive 10.5%.

Margins are up, too. The firm reported an underlying pre-tax profit margin of 7.5% for the period, compared to 5.4% last year. Sales growth and cost control are said to be responsible.

It’s always worth checking what’s excluded from underlying figures, but in this case Greggs scores a clean bill of health. My sums show an statutory operating margin for the half year of 7.3%, compared to 5.1% for the same period last year.

The vegan sausage roll gets several name checks and is said to remain a big seller. In my view, the free publicity generated by this product is potentially even more valuable than its sales. It was definitely an inspired innovation.

However, sausage rolls aren’t the main driver of sales growth. This is said to be strongest in the breakfast segment of the day. Another important area of growth are the firm’s post-4pm hot food offerings, such as pizza and a drink for £2.

Accelerating investment: This may be why the shares have fallen slightly today. Instead of upgrading forecasts for the year based on strong H1 results, the firm has decided to bring forward some of its planned investment in growth and supply chain improvements.

Full-year guidance has been left unchanged, but capex will be lifted to £90-£100m, compared to £73m last year. This cash will be invested in the company’s supply chain, including manufacturing and new automated warehouse facilities. The increase in spending is said to relate to timing only — no new spending has been planned.

I don’t see this as a concern, personally. Over the long term, it should be benefit shareholders, assuming growth remains strong enough to utilise any additional capacity.

IFRS lease liabilities: As we’ve come to expect, Greggs’ strong profits are supported by strong cash generation and a debt-free balance sheet — net cash was £85.9m at the end of the half-year period.

However, the firm is now reporting its results in line with the new IFRS 16 lease accounting regulations. This requires companies to show lease liabilities in full on their balance sheet, together with a corresponding right of use asset.

GRG 1h19 lease asset

GRG 1H19 lease liability

We can now see more easily that Greggs has outstanding lease liabilities totalling £277m. A hefty sum, compared to annual profits of about £90m. However, it’s not something I see as a concern, given the group’s strong trading and 20%+ returns on capital employed.

Strategy insight: The UK food-to-go sector has changed beyond all recognition over the last 30 years. Gregg’s chief executive, Roger Whiteside, has been an influential figure in this sector throughout this period.

In my view, the strategy that he’s rolled out at Greggs is the end result of these decades of experience. If you’d like a deeper insight into what Mr Whiteside is trying to do and why, I’d strongly recommend this longish read.

My view: Greggs remains a class act. However, the shares have risen by 121% over the last year and now trade on about 27 times forecast earnings. The dividend yield has fallen to just 2.1%.

I’m struggling to see much value here. The shares have fallen today despite the firm reporting record results. In my view, this hints at the sharp downward re-rating we could see if Greggs disappoints the market in any way.

I suspect better buying opportunities may be available in the future.

Jupiter Fund Management (JUP)

  • Share price: 383p (+1%)
  • Market cap: £1.75bn

Interim results

The active fund management sector is continuing to experience challenging trading. Fund managers are battling net outflows and pressure on fees from cheaper passive funds.

For investors who think that traditional active management is doomed, it makes sense to avoid fund managers altogether. My view is more nuanced. I think (and hope) that we’ll see a market where managers who can add value and provide more specialised exposure continue to thrive.

Mixed results: One of my preferred choices in this sector is FTSE 250 firm Jupiter Fund Management. Today’s half-year results are the first under new chief executive Andrew Formica and paint a mixed picture.

Net outflows reduced to £1.1bn during the half year, compared to £2.3bn during the same period last year. Despite this outflow, the value of assets under management rose by 8% to £45.9m, thanks to market performance and additional ‘alpha’ generated by the firm’s strategies.

The firm’s net management fee margin for the half year was 0.84%, which is consistent with 2018 (0.83%) and 2017 (0.85%). So Jupiter appears to be maintaining its pricing power at the moment.

However, the majority of fees based on assets under management. Average AUM has fallen from £48.6m during H1 2018 to £44m during for H1 2019. So profits have fallen accordingly — pre-tax profit fell by 16% to £81.4m.

My view: Today’s results show how fast profits can fall at assets managers if AUM falls, either because of net outflows or market movements. A market crash could push profits a lot lower.

However, Jupiter says that 72% of its mutual fund assets have outperformed their benchmarks over the last three years. My view is that this stock is one of the more attractive options in this sector.

According to financial data providers, the company has a track record of generating returns on equity of more than 20%. With the shares trading on 13 times forecast earnings and offering a yield of more than 6%, I think there could be some value on offer here.

Sabre Insurance (SBRE)

  • Share price: 270p (-2.7%)
  • Market cap: £676m

Interim results

I just wanted to give a quick mention to this FTSE 250 motor insurance group, which floated on the market in 2017.

Sabre specialises in drivers who attract high premiums. The firm has considerable experience in this area and enjoys unusually high profitability, compared to rivals:

SBRE 1H19 results summary

By way of contrast, Direct Line Insurance (in which I own shares) expects to achieve a 93%-95% combined operating ratio this year.

An insurer’s combined operating ratio represents the sum of its claims losses and expenses, as a percentage of premiums received. It’s a measure of underwriting profitability, excluding investment returns.

A figure of less than 100% implies profitable underwriting, but the lower the figure the better. Sabre’s combined ratio of 71.5% appears to reflect its specialist focus. It appears that competition for high-risk drivers’ insurance business may be lower than for less risky drivers.

The company’s policy is to prioritise profitability over volume. The impact of this is clear — gross written premium fell by 7% during the half year and pre-tax profit fell by about 5%.

My view: The motor insurance sector is out of favour at the moment. Firms are suffering from tough competition on pricing and limited growth opportunities.

Sabre Insurance looks like an interesting alternative with attractively high margins. In general, I would support Sabre’s policy of prioritising profitability over volume.

The main risk I can see in the medium term is that this firm’s superior profitability may tempt rivals into this market. This might force the firm to sacrifice profitability to avoid a serious loss of market share.

I don’t know how likely this is, but with a 7% dividend yield on offer, I feel that Sabre could be worth further research.

That’s all I’ve got time for today, thanks for following along so far.

I’ll be back tomorrow with more midcap news.





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