Electronic Arts Inc. (NASDAQ:EA) began a precarious slide in October. EA stock fell from a high of $120 to $100 by early December. It shook a lot of video game investors and made some wonder if the trend was over.
Just seven weeks later, however, Electronic Arts stock is up a robust 15%. With third-quarter earnings on January 30, what should investors do?
Battlefront II Controversy And Effects
A few months ago, concerns were mounting about displeased customers.
The company’s new Star Wars Battlefront II came under fire for its aggressive use of microtransactions. Microtransactions are traditionally in-game purchases that unlock level-ups, customization and other unique features.
Video game companies love these bread-and-butter transactions thanks to the high-margins attached to them. Gamers, not so much.
The complaint when it came to Battlefront II was that vital game elements were behind a paywall, and gamers were paying full price for an incomplete game.
Should investors worry about the resulting reduced microtransactions at Electronic Arts?
I don’t know that I would worry too much about it. At least not yet.
For one, Battlefront II was still the No. 2 seller for the all-important month of December. Further, its Madden 18 game came in at No. 4 for the whole year. Second, analysts’ estimates are far from robust for the fiscal third quarter. They are looking for an 11.3% decline in earnings and a 2.4% drop in sales. With expectations low for the quarter, it gives the company a chance to impress Wall Street.
The economy has been strong and the trend in video games has been impressive. Just look at how Activision Blizzard, Inc. (NASDAQ:ATVI), Take Two Interactive Software Inc (NASDAQ:TTWO), Nintendo Co., Ltd (ADR) (OTCMKTS:NTDOY) and Sony Corp (ADR) (NYSE:SNE) have been doing. There’s no reason to think that Electronic Arts did not have a good holiday season.
Exceeding analysts’ estimates could bode well for the stock. At the same time, a meager earnings beat — or heaven forbid, a miss — could weigh on the stock following a quarter that’s already expected to be down year-over-year.
Fundamentals for EA Stock
Expectations pick up for Q4 2018. Analysts expect sales to grow 8.8% and earnings to jump almost 25%. That’s great growth. For the full-year, estimates aren’t quite so rosy. Forecasts call for just 7.1% earnings growth and 4% sales growth.
Is this stock worth 27 times 2018 earnings estimates?
While at first glance the answer is a resounding “no,” consider another positive: margins and cash flow.
At year-end 2015, profit margin stood at 15%, while free-cash flow was under $1 billion. As we near fiscal year-end 2018 — without the key final holiday count, notably — those figures stand at almost 25% and $1.5 billion, respectively. An increase of more than 60% and 50% is no small feat and those features likely only improved this quarter.
Further, don’t forget about next fiscal year. While we still have one more quarter to go in fiscal 2018, forecasts call for 17% earnings growth and 8.4% sales growth in fiscal 2019.
However, I have been a long-time bull of ATVI stock. Working in ATVI’s favor was the robust sales results of Call of Duty: WWII. Further, Destiny 2 had a strong launch. Both games found their way in the top 10, coming in at No. 1 and 3 for the year. ATVI also launched its highly anticipated Overwatch league.
Further, ATVI did not have any negative press around micro-transactions. Is it a better buy than EA stock? Investors can buy a basket of video game stocks if they want to ride the industry’s momentum without having single-stock risk. However, if I had to choose between EA and ATVI, I would side with the latter.
Working in favor of Electronic Arts stock? It is the cheapest among the “big three” in the video game world — EA, ATVI and TTWO.
Trading EA Stock
EA stock has an interesting chart. After its late-2017 breakdown, shares have finally broken through downtrend resistance (black line). It’s now riding a sharp trend-line higher (blue).
Click to Enlarge
At the same time, the stock getting to the bottom of its prior range support, in that $114 to $117 area. It’s not yet clear whether shares are consolidating and gearing up for a move higher or whether this level will act as resistance. Its earnings results may very well be the deciding factor in this outcome.
Unfortunately, this coin-toss scenario leaves us without much edge when it comes to EA stock. Those that have been long can stick with it. But new buyers may want to wait for a better opportunity.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
