If
I had to list five things I like about the Character Group PLC, the London AIM
listed small cap, they would be:
- simple unchanging business;
- business with a strong competitive advantage, demonstrated by consistently high returns earned on invested capital;
- highly cash generative;
- strong balance sheet supported by healthy cash balance and real estate; and,
- a management team with significant skin in the game and a solid track record.
Add
to the above the 4.2% dividend yield and 12% free cash flow yield implied by
the current share price, and you have a stock with significant value. I believe
that the recent fall in share price - ~14% fall over a year – owing mainly to
fall in international sales resulting from Toys R US’s bankruptcy is a
temporary blip and offers a good opportunity to buy.
The
business
CCT is the largest independent toy company in the UK. It designs
and manufactures toys and games, mostly under licence and based on popular
television, film and digital characters. It also partners on an exclusive basis
with other overseas based toy producers to market and distribute their product
in the UK. Its customers include the major UK toy retailers, UK Independent toy
stores and a wide selection of overseas distributers.
With an impressive portfolio of tried and
tested winners in Peppa Pig,
Little Live Pets, Stretch, Mashems and Teletubbies and an eye catching list of new comers which
include the Pokémon products to be launched in summer 2018 and
two new award winning toys in Stretch
Armstrong and Laser X, CCT’s immediate customers should have no difficulty
in grabbing the attention of their immediate customer base: the Pre-school
child. There is no doubting the fact that the contents of many a parent’s
wallet will continue to flow smoothly, ultimately to CCT (most parents with pre-school
kids will attest to the fact that Peppa
Pig is the dictator who rules childhood).
CCT’s management appear extremely enthused with
their product line, calling it the best ever in the company’s history. I believe
their optimism is justified; the second half of 2018 and onwards augurs well
for sales growth, profitability and free cash flow.
Consistently
high returns on average equity
For a business with no long-term debt or liability,
return on equity is a good measure of quality of operations. One can do all
kinds of qualitative analysis to gauge a business’s competitive advantage, but
numbers speak lounder than words. If a business has consistently earned high
returns on capital, it has an edge. CCT’s competitive advantage becomes
apparent when you look at the consistently high return on average equity the
business has generated.
Bar a couple of bad
years, the business has consistently generated superior return on average
capital, generating an average spread over my expected cost of capital of 41%
over the past 11 years. This is no mean feat and would not be possible without
an edge in my opinion.
Highly cash generative
A businesses cash generating
capacity is the single most important yardstick in judging its value. The
returns on equity and earnings matter very little if there is no free cash flow
backing it. Earnings are a matter of opinion, but cash is a matter of fact, and
CCT definitely packs a punch by this measure. It is a business that is highly
cash generative, including in down years for earnings. Add to the free cash
flow CCT’s track record of consistently buying back shares and paying a dividend,
and you have winning combination.
Strong balance sheet
The cash generative
nature of the business combined with no long-term liabilities and owned real
estate assets means that CCT has a strong balance sheet. CCT’s net cash balance
of ~£12m and £5.2m book value of owned real estate equates to £0.82 a share or
~19% of the current share price. Based on current share price of £4.75, this
implies a per share value for the operating business of £3.75 equating to a
free cash flow yield of 14%.
Management with skin the game and a solid track record
CCT’s directors own
~22.6% of the company, with its two joint managing directors alone holding
16.6% of the shares. These are individuals with a long track record with the business,
with the two joint managing directors having been with the business since
inception. The board is by far the biggest shareholder in the company and has
significant skin in the game. These are individuals who know the business very
well, have deep relationships in the industry and have consistently generated
shareholder value.
CCT has generated a
total return of 333% over 10 years and an annual return of 13% over the same
period. This compares to the total return during the same period of 1.18% for
the AIM as a whole. During this period, it has reduced its share count by ~47%
through buybacks, using a total of £38m of its free cash flow to buy back its
shares. This has had a positive net effect on the earnings and cash flow yield
for its shareholders. There is no reason to suggest this track record cannot
continue.
A company generating
13% per annum over 10 years for its shareholders is doing well.
Valuation
At a cash flow
yield of 12% (14% FCF yield accounting for net cash and real estate on balance
sheet), a price to earnings ratio of 9x and a dividend yield of 4.2%, CCT is a
compelling value opportunity. The recent share price dip due to overseas sales
fall, owing mainly to the Toys R US bankruptcy, offers a great buying
opportunity. Add to this the best ever portfolio of toys in the company’s
history, management’s optimism for future trading and solid track record over a
very long period, the odds should be in favour for a long-term buy and hold
strategy.
