SIF Folio: “Confident” Character Group Is Back In The Game

13th Nov '18 by Roland Head

3 comments 3348 reads

With Christmas approaching fast, now seems like a good opportunity take a closer look at a company whose profits depend heavily on festive trading.

Toy manufacturer Character Group has had a tough year, thanks to the bankruptcy of top customer Toys ‘R Us last October. But the company’s year-end trading statement in September made it clear that it’s back in the game. Management expect results for the year to 31 August to “comfortably reach market expectations”. That sounds to me like a modest earnings beat is possible when the firm reports at the end of November.

The right time to buy?

You can read Graham Neary’s thoughts on September’s trading update here.

What interests me today is that this £106m firm is also back in my Stock in Focus screen, making it a potential buy for the SIF Fantasy Fund. This is a business that’s always tempted me, thanks to high returns on capital and strong free cash flow.

At the same time, it’s not a stock for which I’d want to overpay. The main reason for this is that the business doesn’t own much in the way of brands or tangible assets. Popular toy ranges such as Peppa Pig are all produced under licence. So the firm is dependent upon its reputation and commercial success to keep winning new contracts.

I’m not too concerned about the near-term outlook. The company has already said that “strong demand from our customers” makes it “confident of the prospects for the autumn/winter trading period”.

What interests me more is the stock’s valuation. The shares have four-bagged since July 2013. But most of these gains came during an explosive re-rating that took place from November 2014 to August 2015. Since then, the share price has basically flatlined:

I’d argue that the chart could support another leg up from this level. But to form a more informed view, I think we need to drill down into the group’s quality, value and momentum scores.

Spread: Sharp-eyed readers may notice that Character doesn’t actually appear in the results of the SIF screen. The reason for this is the stock’s spread, which is perilously close to my maximum limit of 4%:

I’m guessing this figure is being rounded up to 4% by the Stocko…

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Merlotman

13th Nov '18

Roland
Thanks for this - very timely as Character (LON:CCT) is on my screen and I am looking at a possible purchase and agree that this is a high quality company at a reasonable price. The issue I have is cashflow. Over a long period e.g. 6 years, average OCF>OpProf and FCF covers divis by 3x. However inter year it is very lumpy. The TTM shows a significant decline in cashflow compared to FYE 2017 (FCF falls to 6p ps). I would expect intra year seasonality given the business they are in but if you look back at the stocko report for the same point last year FCF at 43p ps was higher on a TTM basis than at the end of the prior financial year. The culprit seems to be that receivables as at H1 2018 were over 100% up on H1 2017 despite revenues being down. Should we be worried? Net cash holdings holding are still healthy at the interim stage - or have the terms of trade moved permanently against the company? I guess we will know better next month when the full year results are out. I'm inclined to wait.

simoan

Thanks for this - very timely as Character (LON:CCT) is on my screen and I am looking at a possible purchase and agree that this is a high quality company at a reasonable price. The issue I have is cashflow.

The problems I have are:

1. Very high director remuneration for the market cap - you'd think the company is their only little piggy bank.

2. They think nothing of releasing profit warnings during market hours.

If you can't trust management, it's uninvestible IMO, no matter what the Stockranks may say.

All the best, Si

Roland Head

15th Nov '18

Merlotman,

I agree that short-term cash flow does seem lumpy. I believe that two factors have distorted the figures over the last 12 months -- a £3.8m non-cash movement in the value of hedging instruments, plus the failure of Toys 'R Us. I assume the closure of a major retailer will have required more heavily discounted stock clearance than usual over the festive/new year period.

These unusual events should fall out of the figures during the next two reporting periods.

Alongside this, I'd guess that new contract wins, stock builds for Christmas and any acquisitions will all have an impact that may vary from year to year.

Unpicking all of this in the accounts isn't straightforward, but given the group's £14m net cash balance and decent track record (in my opinion), I'm prepared to trust management on this.

As you say, we'll find out more when results are published at the end of November!

Regards,
Roland

SIF Folio: “Confident” Character Group is back in the game

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Roland Head

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