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EA Stock Is Fairly Valued, but That Doesn’t Mean It Can’t Still Pop

Thomas Niel

Electronic Arts (NASDAQ:EA) has been holding steady. EA Stock has traded between ~$87 and ~$100/share since the spring of 2019. But with the release of earnings on July 30, shares saw a nice short-term pop. The strong performance during the last quarter pushed the price from $87.93 up to as high as $97.07/share.

EA Stock Is Fairly Valued, but That Doesn't Mean It Can't Still Pop

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Is this short-term performance indicative of a long-term rally? The company is fairly valued, but with catalysts in the pipeline that could materially improve earnings, there could be some upside.

Strong Earnings Boost EA Stock

Results for the quarter ending June 30 beat expectations. Thanks to the performance of FIFA Ultimate Team, The Sims 4, and Star Wars: Galaxy of Heroes, total revenue moved to $1.2 billion, up from $1.137 billion in the prior year’s quarter.

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Looking forward to the full year, EA expects FY2020 (year ending June 30, 2020) to show revenues of ~$5.375 billion, a single-digit percentage increase from FY2019 (revenues of $5.022 billion). But these small gains in revenue understate earnings growth potential. There are several catalysts in the pipeline that could boost earnings over the next few years.

The transition from physical to digital sales of video games continues to improve operating margins. Operating income for the quarter ended June 30 zoomed to $415 million, up 38% year-over-year.

There also are new potential revenue streams. The launch of the EA Access service gives the company exposure to the subscription business model. By monetizing the company’s existing library of titles, the company can generate new streams of revenue without increasing development costs.

With $3.5 billion in cash on the balance sheet, EA has plenty of options to improve shareholder value. They could accelerate their current share buyback plan. They could also shore up their mobile business via bolt-on acquisitions of smaller video game publishers.

Electronic Arts Stock Trades Similar to Peers

EA trades a fair valuation relative to its publicly-traded peers. Electronic Arts stock trades at a forward GAAP Price-to-Earnings (P/E) ratio of 10.9, but this figure is skewed by a recent income tax benefit. With this in mind, it may be more appropriate to use the company’s Non-GAAP forward P/E ratio of 20.2. Enterprise Value/EBITDA (EV/EBITDA) for the trailing twelve months (TTM) is 18.4.

Compare this with Activision Blizzard (NASDAQ:ATVI) and Take-Two Interactive (NASDAQ:TTWO). ATVI trades at a forward P/E of 37, and an EV/EBITDA ratio of 14.4. TTWO trades at 33.7 times forward earnings, and at an EV/EBITDA ratio of 44.74.

This makes the current valuation of Electronic Arts reasonable. Compared to the market, EA stock trades at an EV/EBITDA ratio in line with the valuations of S&P components in the Consumer Discretionary sector (EV/EBITDA of 15.3).

EA probably deserves a higher valuation, as the company has a tremendous economic moat. Their portfolio of video game franchises allows for high operating margins. The durability of the franchises protects the company. Compare EA to the likes of media giants such as Disney (NYSE:DIS), which have been able to trade at high valuations on the merits of their intellectual property.

The Bottom Line on EA Stock

At the current price, Electronic Arts trades at a reasonable valuation, but the company has many core strengths.

Their portfolio of sports games (FIFA, Madden) are durable franchises. They produce consistent sales thanks to annual game releases. The launch of free-to-play games such as Apex Legends helps them gain market share in the growing “battle royale” (think Fortnite) video game genre.

The transition from physical to digital delivery has and will continue to improve operating margins. Add in the potential growth from the EA Access subscription service, and the company has a clear path to earnings growth and stock price appreciation.

In today’s market, Electronic Arts stock is fairly valued. A market-wide correction would impact the stock’s performance, but at the current trading price, investors can enter the stock at a fair valuation. Electronic Arts stock may be more of a buy if the stock dips again, but with the current growth catalysts in play, the company could see a nice boost in the near-term.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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