Character Group: Is it sustainable?

27th Apr '16 by fizzlebiz

5 comments 8641 reads

First half revenue grew rapidly at Character Group but I still wonder how sustainable today’s level of profit might actually be.

Revenue grew 12% on the same period last year. Underlying PBT is up 23% to £8.6m. Management note the strong performance of the top ten largest brands and, in particular, Peppa Pig. Net cash now stands at £14.5m, £1m worth of shares were bought back in the first half.

In all, it looks like good progress has been made in the period. I remember Character had a really bad first half a couple of years ago. Disclosure has improved somewhat since then and the proportion of international sales continues to rise. The management transition appears to be progressing smoothly too.

By my estimate, and this is not including cash, Character is trading on a forward PBT multiple of ~10x. At first glance, this looks pretty reasonable.

The top-line is growing at 12%. Gross margins are being diluted by higher proportions of international sales but all the margin loss and then some is being recovered on flat operating expenses. I don’t think we can base our whole investment case on PBT growth>revenue growth but a few ppts difference seems reasonable.

The main risk to this case is that we repeat the example of a few years ago. Character operates in an industry fuelled by fashions and fads, it is fairly easy to turn up with the wrong stock when Christmas rolls around. That being said, the worst case did happen a few years ago. It took all of a couple of years for the business to hit its stride again.

A more subtle variation on the same point is the question of how sustainable today’s profits are? Okay, we know that the company will hit a bad spot with inventory sooner or later but is it possible to replicate today’s success with Peppa Pig and the Teletubbies?

I am not so sure. For the consumer, these products only last through childhood. Every few years, you need to reinvent your portfolio. Production companies will always produce these brands, they will always need Character to monetize this investment but could the company get stuck with a few average brands for a number of years? I would think so and this possibility, in my view, ruins the investment case at today’s price.

Maybe I am…

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johnrosier

27th Apr '16

"For the consumer, these products only last through childhood. Every few years, you need to reinvent your portfolio. Production companies will always produce these brands, they will always need Character to monetize this investment but could the company get stuck with a few average brands for a number of years? I would think so and this possibility, in my view, ruins the investment case at today’s price."

Surely every few years you don't need to "reinvent your portfolio" because a new generation of little kids arrive and watch the Teletubbies etc just like the generation before!

fizzlebiz

28th Apr '16

Well, look at the business five years ago...most of the brands are still active but it is only Peppa Pig and Fireman Sam out of what appear to be the big brands...and I am not sure that Fireman Sam is as big now as it was then.

Compare Character's strategy with Hasbro/Mattel. Both of these companies licence brands but the core of their business is in-house brands that they own outright. That is why their equity is so valuable because they own something lasting. Even if you assume that Character can retain licences indefinitely (they can't), there is a slim coincidence between brands that are small enough for Character but have lasting attraction to consumers. Simply observing that Teletubbies exists doesn't really prove anything (and misses the point that the series was out of production for a decade and a half).

So some of these brands do exist, I am aware of Star Wars, but it is telling that the largest companies chose not to rely on the kind of income that Character appears to rely upon. As far as I can tell, after many years of trying, Character hasn't produced any successful franchises. If I am buying a company in this industry though, this is where most of the equity value is going to come from (you can't apply a multiple to earnings that will only last a few years).

janebolacha

Licences are usually for terms of three years.
There are usually provisions for early termination,
although I understand these are only rarely invoked.
Nevertheless, that does create an inherent impermanence.

Character (LON:CCT) is a well-run operation but it is a different animal
from companies such as Mattel or Hasbro and the
relatively short-term visibility means that its PER is
bound to be always lower.

They are dependent on obtaining revolving licences, rather
than having their own proprietary self-created assets.
That is why they have next to nothing in goodwill and
why they write off rapidly the development costs they do incur.

Effectively, they are at the mercy of policy changes within, say,
the BBC or Entertainment One (LON:ETO). If ITV do bid for and buy ETO and then decide they want to handle differently sales of Peppa Pig merchandise, how will Character (LON:CCT) handle that?

I am not negative on Character (LON:CCT), instead rather cautious.
I have held for seven years but have banked a large
part of my profits now.

Carcosa

30th Apr '16

I sold my holding on the day of the H1 results but keeping an eye on Character (LON:CCT) for any price weakness as an opportunity to buy back in; largely because I do not think the increasing move to international sales has yet to be fully recognised.

Anyone have comments on thereduction of short-term borrowings and what this may/may not imply?

	FY 2014	H1 2015	FY 2015	H1 2016
Short Term Borrowing	£22.2m	£10.6m	£21.2m	£1.8m
Cash	£17.7m	£14.9m	£25.8m	£16.3m

The last time short term borrowing was at this level was ten years ago.

Most short term borrowing are finance advances are advances against trade receivables and import loans to finance working capital requirements.

TraderTim

Jane,

I think the Entertainment One (LON:ETO) point is a valid one. Entertainment One (LON:ETO) has had a rotten 12 months and the price has been hammered - the ITV rumours have been dismissed, but my guess is that potential suitors (ITV, BBC and others) will look at the licences and content rights Entertainment One (LON:ETO) and consider it good value for money. At the current price, talks of a bid do not surprise me at all. The knock-on impact this could have on Character (LON:CCT) I agree is a point of caution. Also, no forecast to grow this year, which surprised me a little given the international expansion beginning to come through on the bottom line with international sales up 57%.

Still holding on to Character (LON:CCT), but have scaled down my holding recently.

Character Group: Is it sustainable?

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Fizzlebiz

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