Shares of video game publisher Activision (NASDAQ:ATVI) plunged in late 2018 alongside the rest of the market on slowing growth concerns. But, unlike the rest of the market, Activision stock didn’t bounce back in early 2019.
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Instead, ATVI kept falling. Through the end of May 2019, the S&P 500 was up 10% year-to-date. The stock, meanwhile, was down 7% year-to-date.
That’s all changed recently. From the end of May 2019 to today, the S&P 500 has climbed 9%. ATVI stock is up a whopping 24% over that stretch.
Why the change of trend in ATVI stock? And, more importantly, will it last?
In short, the change of trend in ATVI stock has to do with investors realizing that, while video-game trends are depressed today, both Activision and the video game market are set for big growth in 2020 and 2021.
Investors are buying ahead of all that growth. But, all that growth still isn’t fully priced into the stock, and the fundamentals say that this stock should trade north of $60 within the next 12 months.
As such, while I like ATVI stock less at $53 than I did at $43, I still like Activision stock here, and think that there’s healthy upside potential in the foreseeable future.
The Fundamentals Are Rock Solid
The core fundamentals underlying Activision stock are rock solid and pave the way for this company to have an outstanding 2020 and 2021.
Big picture, the video game market is a secular growth market, with consistent double-digit sales growth driven by secular trends such as increasing digital channel consumption, global urbanization, and next-gen tech innovation.
This secular growth market has huge catalysts on the horizon, with the launch of a new generation of video game consoles in 2020 – the first new-gen console refresh cycle since 2013. New-gen console refresh cycles always provide huge upward catalysts for the whole market. This one should do that even more because these new consoles will have cloud gaming capability.
In this secular growth market with huge catalysts on the horizon, Activision is a very important player with broad exposure. Everywhere the gamer is, Activision is there, too. In the console world, Activision owns arguably the video game world’s most successful franchise ever, Call of Duty.
In the desktop world, Activision owns fan favorite titles such as World of Warcraft and Diablo. On the mobile front, Activision is behind arguably the mobile world’s most successful franchise ever, Candy Crush. On the eSports front, Activision owns the world’s most fleshed-out and popular eSports league in Overwatch League.
Because of this broad exposure, as goes the video game market, so goes Activision. In 2020 and 2021, then, as the video game market surges higher on the back on new console releases, Activision’s revenues and profits should surge higher, too, which should lead to a sizable rally in ATVI stock.
Activision Stock Has Upside
The numbers here for ATVI to be a $60 stock in 12 months aren’t too hard to follow.
The global video game projects to grow sales at an 8% clip in both 2020 and 2021. Activision, given its broad and healthy exposure to the new console refresh cycle in late 2020, projects as a bigger grower during this stretch. At present, the Street is modeling for 8-11% revenue growth in 2020 and 2021 for Activision. That seems about right me.
During this stretch of high single-digit to low double-digit revenue growth, profit margins should trend higher thanks to three things.
First, favorable demand drivers will give Activision strong pricing power on its new releases, leading to higher gross margins. Second, favorable engagement drivers will increase the volume of micro-transactions in 2020/21, which should also boost margins. Third, high single-digit to low double-digit revenue growth is enough to drive positive operating leverage throughout the whole business.
Big picture, then, Activision projects as a high single-digit to low double-digit revenue grower over the next two years, with favorable upside margin drivers. That should produce low to mid-teens EPS growth. Indeed, Wall Street expects Activision to grow EPS by 15% in 2020 and 13% in 2021, to a 2021 EPS base of about $2.85.
The video game stocks – Activision, Electronic Arts (NASDAQ:EA), and Take-Two Interactive (NASDAQ:TTWO) – historically trade around 22- to 23-times forward earnings. Based on the midpoint of that historically average valuation, $2.85 in 2021 EPS should correlate to a 2020 price target for ATVI stock of about $64.
Thus, over the next 12 months, ATVI stock has visible and fundamentally supported upside to levels above $60.
Bottom Line on Activision Stock
Activision stock is a long term winner that got ahead of itself in 2018 and has since taken a tumble, but with shares now more appropriately valued, the secular growth narrative in-tact, and significant upside catalysts on the horizon, ATVI stock looks ready to get back to winning mode over the next few quarters and years.
As of this writing, Luke Lango was long ATVI and EA.
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