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Character Group (LSE:CCT) is a toy-idea company: coming up with designs for new toys; striking deals with franchise owners (e.g. Disney); arranging out-sourced manufacturing, and; supplying retailers and consumers. There are a few companies with similar business models in the world. The four biggest are Lego, Mattel, JAKKS and Mattel. I’ve looked at their annual reports going back a few years to gain some insight into the rates of return they earn on capital.
The measure I’m using is profit after tax divided by net assets after the deduction of any goodwill figure in the BS. Goodwill is deducted because the managers do not have the use of that “capital item” to produce profits.
I’ve also gathered information on some smaller companies – see table. There are a few more companies in this segment of a reasonable size but their accounts are difficult or impossible to obtain, usually because they are private.
One of the largest is an Australian company, Moose Toys. Newspaper articles state that this a very successful company, implying it generates high rates of return on capital.
Returns on capital employed (profit after tax/(net assets less goodwill), in millions)
| 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||
| LEGO (DKK) | 8.1/21.8 = 37.2% | 7.8/20.7 = 37.7% | 9.4/20 = 47% | 9.2/17.8 = 51.7% | 7/12.8 = 54.7% | |||||||
| Hasbro ($) | 220/1268 = 17.5% | 397/1257 = 31.6% | 551/1292 = 42.6% | 452/1071 = 42.2% | 416/873 = 47.7% | |||||||
| Mattel ($) | -533/negative | -1,055/negative | 318/1020 = 31.2% | 369/1248 = 29.6% | 499/1555 = 32.1% | |||||||
| JAKKS ($) | -43/16 | -83/59 | 1/92 = 1% | 23.2/109 = 22.3% | 21.5/101 = 21.4% | |||||||
| Flair Leisure (£) | 1.2/9.65 = 12.4% | 6.1/14.4 = 42.4% | 7.3/9.6 = 76% | 4.7/8.2 = 57.3% | 3.6/8.5 = 43.9% | |||||||
| Funko ($) | 28.3/184 = 15.4% | 5.6/170 = 3% | 26.9/negative | |||||||||
| Spin Master (Canadian)($) | 155/538 = 28.8% | 161/395 = 40.8% | 100/234 = 42.7% | 47/120 = 39.2% | 62/? | |||||||
| Tandem (£) | 1.62/7.2 = 22.5% | 1.74/5.9 = 29.5% | 0.78/3 = 26% | 1.0/2.6 = 38.5% | 1.63/2.7 = 60.4% | |||||||
| Character (£) | 7.5/34.1 = 22% | 9.6/31.8 = 30.2% | 10.1/26.8 = 37.7% | 10.8/22.9 = 47.2% | 10.2/15.2 = 67.1% | 5.9/9.9 = 59.6% |
Notes:
- JAKKS, Hasbro and Mattel suffered from the Toys R Us disaster in 2017-18.
- With Character, the majority of the NAV figure was cash: 2019: £30m, 2018: £34.6m, 2017: £28.8m, 2016: £28.6m, 2015: £25.8m, 2014: £17.7m. Including this cash has depressed the return on capital figure. If cash is excluded NAV shrinks so much that the return on net assets is often over 100% for a year.
Observations
Clearly, the companies in this industry generally generate rates of return far greater than the cost of equity capital, say 8% pa.
A FRAMEWORK FOR CONSIDERING WHY HIGH RATES OF RETURN OCCUR
Professor Michael Porter gave us the Five Competitive Forces framework for thinking through the extent to which competition pushes down the rate of return in an industry to the competitive floor, i.e. producers are given just enough to incentivise them to stay in the game.
Thinking in this area starts with the notion that competition and therefore power to push up prices relative to costs of production is not just about rivalry between producers within that industry but is influenced by four other factors.
Sometimes rivalry within the industry is low but poor rates of return are generated because suppliers of a key input have a great deal of power to charge high prices, e.g. movie stars can take fees so high that a “successful” film actually loses money.
Alternatively, poor returns are due to cu
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