Gamble of the week: Model maker back on track

Right now, life is quite tough for toys and model railways group Hornby. Three profit warnings this year have seen the value of its shares chopped in half. A big bet on selling more toys on the back of the London Olympics has backfired for example, it made Scalextric sets based on a velodrome, and London bus models, which didn't sell very well amid a general glut of Olympic-related merchandise and it's now sitting on lots of unsold stock. It will have to slash prices to shift it.

On top of this, outsourcing the manufacturing of its model trains to China has been a nightmare. Unreliable suppliers have prevented Hornby from supplying enough products to key markets. These two factors, combined with tough markets, mean that Hornby won't make any money this year.

It's very easy in this context to conclude that Hornby has had its time, and that it's something of a throwback. The naysayers point out that these days, many children prefer to play with computer games rather than train sets, Scalextric, Airfix models and Corgi cars.

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This may be true, but I still think it's too early to give up on Hornby's altogether. After all, last year the company had sales of £64m, trading profits of £4.7m and underlying earnings per share of 9.4p. If it can sort out its short-term problems, it could get back to these levels of profits within a few years, which would make it look cheap at the current share price.

Hornby (LSE: HRN)

So the big question is can it? Getting Chinese companies to make your products for you is no longer the straightforward decision it once was. Chinese workers are now looking for higher wages, which means that Western companies are having to pay more to get their work done for them.

If they then can't make what you want, when you want it, then the whole business case for outsourcing to China gets thrown out the window, which is one reason why a lot of businesses are now re-shoring' bringing manufacturing back to their own countries.

It will take a bit of time, but Hornby can fix this problem. Already its model paint brand, Humbrol, has shifted two-thirds of its production back to Britain from the Far East. As chief executive Frank Martin told The Daily Telegraph: "If you include the expense of freight then the cost differences [between China and the UK] become negligible."

It's also worth remembering that Hornby has some great brands. They may not be as popular with today's children as they once were, but there are plenty of adult collectors out there who will pay surprisingly large sums of money to buy replicas of model steam trains or Airfix models. For instance, Germany has a decent-sized model railway collectors' market, which Hornby has been able to sell more of its models to.

But to really build up sales, it needs to broaden its appeal. To do this it needs to sell cheaper products. Many of its top-end train and Scalextric sets are simply too expensive for many families. Hornby is already trying this strategy with Airfix models and Corgi cars and it seems to be working quite well.

The recent appointment of a new chairman may also shake things up a bit. Roger Canham is chairman of Phoenix Asset Management, which owns more than 10% of Hornby's shares. There's a lot of work to do, but buying Hornby shares at today's depressed levels may reward the patient investor.

Verdict: Speculative BUY at 65p