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Character Group: Reiterate buy stance at 186.5p and increase price target from 204p to 246p

Character Group has today announced a strong first half trading statement and a move into the “toy construction” sector of the toy market – first half revenues are expected to be at least 33% ahead of last year. On the back of this we have increased our forecasts and our target price, from 204p to 246p and with the shares at 186.5p we reiterate our stance of buy.

The key strength displayed by Character Group is its continuing ability to develop and refresh its portfolio of leading brands – the move into the toy construction sector with new lines based on Dr Who and the HM Forces brands available by the spring of this year and due to be showcased at the Olympia Toy Fair from 25th to 27th January. The company has a strong track record of developing and commercialising branded toys and a profound knowledge of suppliers & buyers. The ‘celebrity’ toy line-up of branded characters includes, Peppa Pig, Postman Pat, Fireman Sam, Scooby Doo, Bob the Builder and Doctor Who.

That is for the future. The company also announced that Christmas trading was strong and, as a result, first half sales to February 28th 2011 are expected to be at least 33% ahead of last year.Two products from the Character portfolio were in the Toy Retailers Associations 2010 Christmas Dream Dozen List; Fireman Sam, Deluxe Fire Station (priced at GBP29.99) and ZhuZhu Pets Grooming Station (priced at GBP22.99).The strong sales growth was accelerated by the distribution of Zhu Zhu Pets, but the whole portfolio has increased its market share.

The Toy Portfolio is proving its longevity by attracting new generations of children and we expect continued sustainable organic sales growth. Character enjoys significant operational gearing as increased sales to national High St. chains such as Argos involve little additional overhead costs and consequently profit margins are rapidly increasing. We have today significantly increased our profits forecasts for 2001/2011 and 2011/2012. And with the company having spent GBP10 million on share buybacks in the last year – a trend we expect to continue – the outlook for earnings growth is even brighter.

Character’s operations are international, with the group employing around 156 worldwide (UK 98, Hong Kong / China 58).The four founding directors have been with the company since its inception and there are two non execs. Character’s in-house team designs and develops the toys for nearly all its brands, which are all among the top 50 UK Toy Brands. The Brands tend to be licensed on an ever-green basis. The main criteria to success in branded toy distribution are: TV exposure, playability with skill learning, good quality, safe to play while keeping to strict price points and developing renewable/ repeat purchases. Products are generally supported by TV adverts and Point of Sale promotions.

Character’s directors have a proven track record of finding best selling toys, so we expect that you may soon hear of ‘Squinkies’ which is a range of collectable figurines which come in a bubble (www.squinkies.com). The success of its own developed brand, HM Armed Forces Collection could lead to further own brand development. Since HM Armed Forces was launched in 2009 growth expectations have been exceeded and the range is being expanded with new vehicles and figures. Character’s products are price point lead, with an average RRP of GBP9.99, and with the mix of quality, innovation and ‘in-demand’ products, the company is confident of progressing despite the tough economic environment. Character has a positive working capital cycle with solid banking relationships giving substantial working capital headroom.

The strategy of repurchasing shares for cancellation at a price the Board believes undervalues it is set to continue. Since January 2010, more than GBP12 million worth of shares have been purchased and then cancelled at prices of up to 150p. On the back of this trading statement we have increased our current year revenue estimate from GBP90 million to GBP93 million and our 2012 estimate from GBP95 million to GBP98 million. At a pre-tax level we have increased our 2011 estimate from GBP8 million to GBP9.25 million and our 2012 forecast from GBP8.9 million to GBP10.2 million. And we have increased our 2011 earnings per share forecast by 13% to 24.86p while the 2012 forecast has been hiked by 11.9% to 27.4p. The dividend has been left unchanged at 5p and 5.5p respectively. The forecast payout is more than four times covered by earnings and there are no working capital constraints on growth and so the risks on the dividend are on the upside. We value the shares on 9 times forecast 2012 earnings and as such our target price is increased from 204p to 246p and at 186.5p our stance remains buy.