Investment Decision Making between Games Workshop and Hornby Finance Essay

The basis for this analysis is to advise Mr. Curry on an investment. The client has a huge portfolio of shares and has recently inherited a big sum of cash which he also wishes to invest in shares. He has a broad portfolio of shares, but not that sound enough when it comes to games retailing sector. So the author over here looks at suggesting the client , to invest in one of the following companies namely Games Work Shop group PLC & Hornby PLC. To make it further effective, the author has considered the last three year's financial statements of both the companies instead of just deciding on one financial statement. The financial analysis equipment was made use of, in order to compare between the companies which are explained in the statement. Eventually, the author benchmarked it with the industry in which they are present by gathering information from various sources available on the web, books, and journals. Ultimately, necessary recommendations have been made along with some vital measures to be taken before making a speculation.

COMPANIES PROFILE:-

Games Workshop group PLC: It is basically a largest and successful gaming company which was found in 1975 by John Peake and Ian Living Stone . It is a production & retailing company which is located in London. It has introduced a Stock Exchange in 1994. It was originally a manufacture of a wooden board for ames such as back Gammon. Mancala, Nine Mend's Morris and GO games but later became an importer of United Stated of America role-Playing games namely Dungeons & Dragons. Company's over all 65% sales operations is coming from USA , Canada ,France,Spain,Italy,Japan, Germany & Australia (Games workshop ;2000-2010)

Hornby PLC: It is basically a toy company which is abrand leader for UK's railway hobby model. Founder Frank Hornby started his company in ( 1863-1938) and company got patent rights in 1901,after that they establishment of Meccano Ltd in 1907, thus it became one of the classic toys.Meccano Ltd that was taken over by Lines Bros (the parent company of Rovex Scale Models Ltd, manufacture of Triang railways),later on it became Tri-ang Hornby in 1965. New diesels included the High Speed Train (HST) which was a popular model instantly.In year1986 it was floated on unlisted securities market ,and then it becomes a public company. British railways have made some changes for the privatization of Railways. Hornby introduced first commercially produced '00' gauge live steam locomotive in year 2003, company's expands range, more than 650 current items. Company position held for more than 50 years as Britain's leading model railway manufacturer company.(Hornby;2008)

FINANCIAL ANALYSIS:-

It would be via financial tools to help us measure up to the performance and do 'TIE' benchmarking to understand the improved performer of the two. Horizontal and Vertical analysis is followed by ratios. where 'TIE' is benchmarking would be compare the companies

• T -Trend
• I -Industry
• E -Expectation

COMMON-SIZE STATEMENTS:-

In common size statements are generally 'Horizontal analysis compares' the presentation of a company with its own historical data to recognize how the financial statement things change over time (Alexander 2009:816). Now a base year is chosen and all the financial statement items are expressed as an catalogue relative to the base year.It gives a quick guide to specific trends of an individual item(Elliott and Elliott 2008:706). With three years financial statements, this is carried out for Games work Shop Plc and Hornby PLC so that the company's trend is understood. Vertical analysis is carried out on one year's statement. The entire items in the financial statement is expressed in comparison with a selected figure in the statement(i.e.)in profit and loss account all the things are expressed in terms of turnover and balance sheet its expressed in terms of capital employed or shareholder's funds (Elliott and Elliott 2008:710).

RATIOS:-

Ratio analysis describes the relation between different objects in the financial statements. They classify areas of fine and shocking performance and areas of significant vary. The relative usefulness of every ratio depends on what aspects of the company's affairs are mortal investigated. Ratios are powerful tool for understanding and interpreting company accounts(Elliott and Elliott 2008: 665). Number financial ratios can be considered as shown in the appendix but we are going to consider the key ratios of the financial performance, current financial position and the shareholder's return and the related ratios under each are:-

• Financial Performance
• Profitability Ratio.
• Efficiency Ratio.
• Current Financial Position
• Liquidity Ratio.
• Gearing Ratio.
• Shareholder Return
• ROE/ROSF
• TSR

Financial ratios analysis

This section will critically demonstrate and analyze the financial health and performance of the two companies in term of its profitability, liquidity, efficiency, gearing, investment by comparing trends of those ratios as well as looking in deep insight of financial figures between the two companies over three financial years.

Basically, investors are most concerned about their investment return and risk. Based on this sense, we have chosen those mentioned ratios to analysis and explain these two companies' investment value, and also justifications of why they are important to evaluate also are provided with each ratio. Among those, profitability and investment ratios, nevertheless, will be mainly focused for the investment analysis and decision making.Profitability Ratios:

Profitability ratios are the most important ratios to investors in any given industry, because it simply shows how much profit the company has earned over years, does it achieve satisfactory level to investors, banks, and shareholders compared to that of its competitor or the industry. Also by drilling down into figures, profitability ratios can also tell how efficient and effective company conducts its business resources and operation activities such as sales, production or other cost-consumed ones.

This section will examine the reasons why the profitability of GWB is growing upward contrary to that of HB through years, why even generating large sales in 2008 (always twice as much as HB's for 3 years), GWB only achieved very low profit (2,552), nearly one fourth to HB's (9.386) in 2008 and how important cost management can improve the profitability of GWB on one side but reduce HB's on the other side in 2009 and 2010. (in 1000 pounds)

Now, this report is to analyze the profitability of the two companies by looking into its ROCE, and its relationship between ROS and AT and Net Profit Margin ratios:

Return on Capital Employed:

Return on Capital Employed (ROCE) is the key profitability ratio that measures company's profits and business performance. It shows the relationship between the PBIT with the capital employed to make that profit.

Graphs to compare profitability between GWB and HB for 3 years from 2008 to 2010: ROCE, ROS and AT

Describe:

As seen in the graph:

The ROCE of GWG is upward, and that of HB however is downward for the 3 financial years.

Both AT of GWG and HB are slightly downward, however the ratio of GWG (averagely 2.33) is at higher level than that of HB (averagely 1.56)

While ROS of GWG started at very low rate 2.31% in 2008 compared to the ratio of HB 16.85% but GWG has improved dramatically to 7.11% in 2009 and 12.68% in 2010 since HB dropped considerably to 11.21% in 2009 and 9.27% in 2010.

Analyze:

Since ROCE is equal by AT times ROS, and AT of both companies seems to stay unchanged, the significant changes in ROCE between them largely depends on the fluctuations of their ROS ratios

Actually, a significant increase in ROCE of GWG is as a result of an increase in its ROS and a significant decrease in ROCE of HB is as a result of a decrease in its ROS

Also, the average AT of GWG for 3 years is 1.5 times as much as that of HB means the greater effectiveness of using its assets to generate revenues for GWG over HB.

Once again, because ROS is equal by PBIT/ Sales, and the Sales of both companies slightly increase in approximately same proportion (around 1.15 times by both over 3 years), the significant changes in ROS between them largely depends on the fluctuations of their PBIT.

PBIT of GWG has soared dramatically from very low level 2.552 in 2008 to 8.933 in 2009 and 16.045, while a downward trend has been seen in HB's from 9.386 in 2008 to 6.899 in 2009 and 6.004 in 2010. Here is the key point to analyze why they have achieved different performances.

Summary

By all the analysis of past performance and comparison, GWB has performed more profitably and efficiently than HB has. GWB has successfully reduced its production cost as well as maintained its high revenues to generate better business performance and profitability over years.

Liquidity ratios:

Liquidity ratios simply measure how companies can meet its current financial obligations in term of cash or how can assets be quickly transferred into cash when needed.

With that view, current ratio indicates the relationship between company's total current assets and its total current liabilities, and how it can pay short term debts (less than 12 months) from the current assets which are mostly able to transform into cash. The higher is the ratio, the better. Below 1:1 is highly not expected and the ideal figure for this ratio is 2:1.

In the charts, both of these companies have achieved the ratios above 1:1, however, the trends between them are different. GWB has consistent uptrend, starting at low level (relative to HB) 1.4 (times) in 2008, but rising moderately to 1.74 in 2009 and 2.04 in 2010. HB has fluctuated from high level (relative to GWB) 1.87 in 2008, but declining considerably to 1.48 in 2009, and recovering dramatically at 2.11 in 2010.

Liquid ratios have shown the similar trends to the previous ratios between two companies because it is current ratio but deducts inventory asset which is not always easily to turn into cash. As a matter of fact, excluding inventory makes liquid ratios of GWB become relatively higher than those of HB, which means GWB has done better in term of inventory strategies over HB. GWB's inventory has been kept as a consistent level over 3 years around 10.300 accompanied with the increase in total assets which makes the relative proportion between inventory and total asset getting smaller hence higher liquid ratio.

While HB's inventory has been fluctuated (11.890 in 2008, 14.368 in 2009, 12.273 in 2010) and by the same way finally makes that proportion become bigger and hence lower liquid ratio.

Proportion of inventory over total current assets for Games Workshop Group PLc(GWB) and Hornby PLC (HB) over 3 years

The different picture has been seen in Cash ratio when GWB has shown a much higher ability to pay its short term loans in immediate cash than HB. This implies greater risks for HB in the business when it needs cash to cover other operational expenses

Efficiency ratios:

Efficiency ratios evaluate the ability of a company to utilize and manage various resources. In the previous section, AT has been assessed to see how GWB use its assets more efficiently to generate revenues than HB.

Specifically, Fixed Assets Turnover ratio measures how efficiently a company uses its fixed assets to generate its sales. The higher is the ratio, the better. The high ratio means the company has less money tied up in fixed assets for each pound generated and the declining ratio indicates that company has over invested in fixed assets such as plant, machinery, etc.

In the chart, the increasing ratios of GWB for 3 years clearly show the efficient utilization of its fixed assets: 2.89 (times) in 2008, 3.23 in 2009 and 3.31 in 2010. On the contrary, HB has the declining and lower ratios over 3 years: 2.68 in 2008, 2.06 in 2009, 2.25 in 2010.

Thus, HB has performed less efficiently using fixed assets to generate sales than GWB.

Stock turnover period measures for how long inventories are being hold or how well a company can manage its stock level. The lower period is the ratio, the better. It can also help company improve its sales and liquidity performance. Once again, as analyzed in the profitability ratios, GWB has performed better than HB in term of inventory and COGSs. GWB keeps its consistent lower inventory level while reducing cost of goods sold to maximize its profits.

In the chart, however in 2010, the period of GWB is getting higher to 121 days, compared to the previous years: 109 days in 2009 and 113 days in 2008, while HB has reduced this period over 3 years: from 166 days in 2008, to 164 days in 2009 and 138 days in 2010.

Debtors period

Debtors Period is one of most important ratios reflected the ability of a company to collect debts from its credit customers. If the period is high, a company will face difficulty to quickly withdraw its finance to invest in its business operations. It can be seen that GWB's period is much better (2.5 times lower) than HB's, while GWB only needs averagely 30 days to take its debts back and this periods tend to decrease, HB normally needs more than 70 days and this ratios seem not to positively change.

Creditors Period

Creditors period, on the other hand, measures for how long company have to pay for its suppliers. The higher period is the ratio, the better because it can keep cash longer and push the finance risk to its suppliers. GWB's period is still better and 1.6 times longer than HB's for the 3 years, means the pressure of GWB to pay money back to its supplier is smaller than the other.

 Capital gearing:

Capital gearing ratio determines how well a company can pay for its long term loans. It measures the proportion of long term loans over total capital employed. Two reversed trends have been seen for the two companies. GWB started at very high rate of 32.21% in 2008 but dropped to 22.98% in 2009 and dipped to the lowest 0% in 2010, conversely the other started at very low rate of 0.44% in 2008, but climbed sharply to 18.40% in 2009 and 22.22% in 2010. High ratio also indicates the higher risk of HB to pay high interests to banks and the bigger nervousness of its creditors on HB's loans.

 Investment ratios:

This is the most important ratio for the investors and it consists of many ratios which are going to see in detail: EPS, DPS, PE

(Data taken from the 5 financial year summary of GWB and HB 2010's annual reports)

EPS represents the earning of the company as a function of the total number of ordinary shares in issue. (O'Regan 2006:295).The shareholders are interested in EPS as it shows the earnings yield percentage and to estimate future growth which will affect the future share price (Elliott, 2008). The two reverse trends in investment picture have been matched with the previous trends described in profitability ratios. GWB's EPS has been improved substantially as the company generates better profits than it did in previous year. It reaches the highest point 48.4 (p/ share) in 2010, followed by 17.6 in 2009 and -2.4 in 2008, a spectacular trend for investors to look at. Conversely, less profitability, thus less EPS makes HB loose its attractiveness from investors by the downtrend: 9.76 in 2010, 11.17 in 2009 and 16.15 in 2008.

P/E Ratio

The Price/earnings ratio is one of the most important and controversy ratio that measures of the company's performance (O'Regan 2006:298). It represents the market's view of growth potential of the company, its dividend policy and the degree of risk involved in investment. This indicates the relationship between the earnings of the company and its stock market price.

The low P/E means the company is undervalued and vice versa, hence investors might put their money on those stocks rather than those (overvalued) which more than its worth. In this chart, the P/Es of GWB and HB are relatively 8.3 and 15.43 means GWB and HB investors will pay relatively 8.3 pounds and 15.43 pounds for every 1 pound of its earnings, which means that HB's stock is less value attractive than the other by investors. The upward trend of HB (6.19 in 2008, 13.43 in 2009 and 15.43 in 2010) shows its less value attractiveness than GWB (120.58 in 2008, 14.54 in 2009 and 8.83 in 2010) for years.

However, the higher P/E ratio also means the greater of the confidence in future earning power of the company, HB therefore has higher market confidence in stock increase for future. Stock prices of HB is much more fluctuated, and lower than GWB demonstrates its better probability to increase while GWB's stock price is very high and has less space for share price rising.

This point will be assessed more in Investment Advice section.

DPS

Another key investment ratio is very useful for investors to consider is DPS (Dividend per share). It indicates how much dividend a company pays for its shareholders every year or a quarter of a year. As seen in the graph, there were no dividend paid to GWB's shareholders in 2008 and 2009 but a very large dividend proposed 25 (pence/share) in 2010 while there were lower dividends paid to HB's shareholders for 3 years: 8.52 in 2008, 2.7 in 2009 and 5.04 in 2010.

The UK traditional toys and games market grew consistently between 2004 and 2007, but recorded a slowdown in sales in 2008, which brought the value of the market to £2.09bn.

The main product categories in the market are: infant/pre-school toys and games; activity toys; outdoor and sports toys and games; games and puzzles; dolls; action toys; vehicles; electronic toys; plush toys; and other products.

Multichannel retailing (store, catalogue and internet) a vital requirement.

Competitive industry environment:

Costs rising for retailers. Highly seasonal retail market.

Growth in Internet sales.

More channels of distribution opening, particularly supermarkets and the Internet.

Challenges from tougher economic conditions and competitors' for kids' time - console games and Internet.

TV and film plays major role in market.

When the firm's figures seem to hit the ground due to global economic conditions, survival seems to be tough. Now taking this into account, below figure is plotted which reveals a fact that Games Workshop Group PLC has a maximum PBT (Profit before Tax) of 29.57% as of the available year when compared to its close competitors namely Vivid Imagination limited and the Hornby PLC which could only manage to gain a PBT of 18.70% and 9.57% respectively. This clearly suggests us that the Games Workshop Group PLC has been maintaining a decent PBT which eventually gained them a strong market share.

This "economic hit" has lead to the following consequences where,

Consumers do choosy shopping.

The demand curve for the valuable goods had gone down.

Market share:

So as a result of the above changes that have occurred, any given firm in the market needs to make necessary changes as far as their operations are concerned. The comparisons are carried out below. However the necessary recommendations will be made at the end by the report that might possibly remedy the current scenario.

Source:-Fame (2010)

In the chart, the Games Workshop Group PLC is known to be the largest and the most successful tabletop fantasy war games company in the world since it managed to maintain some respectable numbers when compared to the other toy and game industries.

(Games, 2010).

Future prospect and forecast:

Source: (Mintel, 2010)

The above graph shows that Toy industry had reached up to 2,050 million pounds in 2003 year, .after that industry turnover constantly improved to 2,150 million pounds in year 2006, in2007 it reached almost to 2,200 million pounds. In year 2008-2009 industry turnover has been declined below 2,050 million pounds, because of recession effect in market. And if we observe in the year 2010 industry turnover had slightly increased and reached as in year 2003 which is 2,050million pounds.

In future prospector point of view Games work shop Group PLC is doing well compare to Hornby PLC even in recession period occurred during 2007-2009, and the ROCE ratio has increased as well compare with pervious .If we compare with competitor like Hornby PLC doing well some ratios, but some them are lagining behind with Games workshop PLC .The ROCE ratio of Hornby is declined compare with pervious years.

Rising birth rate good news for market.

Smaller average family sizes, older parents

Recommendation:

The performances of the two companies are understood by analysing their ratios. Among the ratios which has been calculated we have to consider the few key points in order to recommend for the investment.

We can recommend the investor by taking the key ratios of the both companies which gives a clear idea of which company is making more profit and low risk. These are the two important aspects that has to be taken into consideration in order to choose a better company to invest.

 

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