Will a Strong Earnings Report Turn Things Around for EA Stock?

EA stock is up 12% year-to-date, but third-quarter numbers may not confirm recent strength in the stock

Video-game publisher Electronic Arts (NASDAQ:EA) had a rough 2018. Headwinds started to build up in the back half of the year, and as they did, EA’s numbers got worse. Sentiment deteriorated and EA stock dropped. Although this was a $150 stock in mid-2018, EA stock closed the year under $80.

2019 has gotten off to a better start. EA stock is up 12% year-to-date, and trading at its highest level since early November. This recent strength has some bulls thinking that fiscal third-quarter numbers — due after the bell today — will be quite good and keep the rally in EA stock alive.

I’m not so sure.

To be clear, I’m bullish on EA stock in the long run. This company has very powerful long-term growth tailwinds, and the stock trades at a relatively depressed valuation, a combination which will eventually spark a big reversal and get the stock back on an winning trajectory.

But, I don’t think the catalyst for that big reversal will be the Q3 earnings report. Instead, I think the earnings report will be more representative of near-term headwinds than of long-term tailwinds, and as such, will leave investors with more questions than answers. If earnings do play out that way, EA stock looks susceptible to pullback, considering its 12% YTD rally.

Overall, I love EA stock long term. But, heading into what could be a weak Q3 report, I don’t think the stock has a favorable setup. As such, investors should continue to exercise patience with this name and avoid getting too optimistic into the print.

The Long-Term EA Stock Bull Thesis Is Compelling

To be sure, EA stock is a long-term winner supported by three robust growth catalysts that are still in their early innings, and a valuation that is reasonable and lends itself to expansion as sentiment improves. Those three robust growth catalysts are:

  • Increased digital download adoption and the birth of video-game streaming.
  • Continued growth in video game micro-transactions and live services.
  • Mainstream emergence and widespread adoption of eSports.

On the digital download side of things, EA has a robust content portfolio with enduring appeal (think franchises like Battlefield, FIFA, Madden, Sims and Star Wars). The enduring appeal of this portfolio means that, regardless of if games are being bought in-store, online or through a streaming service, EA’s games will be purchased. Also of note, EA is arguably the leader in video-game streaming through Project Atlas, and that leadership will prove extremely valuable when video game streaming becomes the norm.

With respect to microtransactions, many of EA’s games lend themselves to these. Titles such as Battlefield and FIFA have plenty of microtransaction opportunities throughout game play, and they are consequently among some of the most profitable games across the entire video game sector.

EA’s titles also lend themselves well to competitive gaming. Already, EA hosts multiple eSports events, including the FIFA eWorld Cup, Madden NFL Championships and NHL Gaming World Championships. EA has also plunged into the mobile eSports world with Command & Conquer: Rivals. Over the next several years, as the whole eSports category gains mainstream exposure, EA’s revenue and profits will explode higher.

Overall, the big-picture fundamentals supporting EA stock remain favorable. Plus, the price is right. Normally, due to the aforementioned big growth catalysts and the company’s high margins, EA stock trades around 25x forward earnings. Today, the forward multiple is below 20. That is about as cheap as you will ever find this stock.

Thus, with EA stock, you have a big-growth company trading at a big discount. That’s a recipe for long term success for buyers at these levels.

Q3 Numbers Will Be Representative of Near Term Headwinds

Expect that EA’s Q3 report will be more representative of the company’s recent struggles, than of its long term strengths. That means the quarterly numbers could disappoint investors betting on a big turnaround here and now. EA stock will likely drop in response, considering it’s up 12% over the past month.

My worries regarding EA’s Q3 earnings report are as follows:

  • The company’s headline release in the quarter, Battlefield V, was delayed by a month, and faced stiff competition from Call of Duty: Black Ops 4 and Red Dead Redemption 2.
  • The consensus read from analysts is that the company’s other headline release in the quarter, FIFA 19, didn’t engage audiences in the way it was expected to.
  • It looks like The Sims 4 Get Famous also didn’t perform up to par. If you look at search interest trends for BattlefieldFIFA, and Sims, it does not look like recent releases drummed up much consumer enthusiasm or excitement.
  • Video game sales were weak in November and December. After robust gains throughout most of 2018, November video game sales were flat year-over-year, while December video game sales inched up just 2%.
  • In the all important December monthBattlefield V finished behind Call of Duty: Black Ops 4 and Red Dead Redemption 2 in terms of dollar sales.
  • Rumors are swirling that ambitious plans for an open-world Star Wars game have been scrapped.
  • Due to legal issues, EA recently removed micro-transactions from FIFA 19 in Belgium.

Overall, EA stock has suffered a series of setbacks over the past few months. Those setbacks will likely show up in the Q3 numbers, and potentially even in the Q4 guide. As such, odds are that this won’t be the report which saves the day for EA stock.

Bottom Line on EA Stock

EA stock is a long-term winner going through some near-term struggles. The upcoming Q3 earnings report will likely be more representative of the near term.  As such, the report could disappoint investors betting on a huge turnaround here and now.

Nonetheless, given this company’s strong long term growth narrative, any post-earnings weakness in EA stock is an opportunity to buy.

As of this writing, Luke Lango was long EA. 

Article printed from InvestorPlace Media, https://investorplace.com/2019/02/strong-earnings-ea-stock-turnaround-simg/.

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