Even If It Doesn’t Come Tumbling Down Soon, EA Stock Is Overvalued

Slow growth means upside is limited for EA stock

Since July, Electronic Arts (NASDAQ:EA) has traded sideways. EA stock currently sells at a high valuation, but the company’s future growth prospects remain a challenge.

Even If It Doesn't Come Tumbling Down Soon, EA Stock Is Overvalued
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Video game sales have been down in 2019. The company’s growth projections in the mid-single-digits are hardly material for a growth stock, but with new consoles coming out in 2020, the company could see a decent sales boost.

Add in the upcoming release of Star Wars Jedi: Fallen Order in November, and Electronic Arts stock may have a few catalysts going for it.

But does this make the stock a buy? The company announces earnings later this month. Let’s take a closer look, and see if EA stock is worth buying at the current trading price.

Recent News and EA Stock

With earnings coming out later this month, investors are waiting to see what’s in store for EA going into 2020. Analyst consensus for the quarter is $1.25 billion in revenue. This is slightly below EA’s guidance from the last earnings release.

In that release, EA projected revenues of $1.31 billion for the quarter ending September 30, 2019. For the full fiscal year (ending March 2020), EA projects revenues of $5.375 billion. This is a slight boost from the prior fiscal year, where sales were $4.95 billion.

As InvestorPlace’s Luke Lango wrote on Oct. 15, EA has two key game releases that can boost performance going into 2020. The first is Star Wars Jedi: Fallen Order. With a new Star Wars movie coming out later this year, the franchise will be top of mind among consumers.

This should help bolster sales of the game. The second major release is the third season of Apex Legends. While interest in the franchise has subsided in the past year, the new release is a vast improvement over Season Two. According to Lango, Season Two contained little new content relative to Season One.

But KeyBanc’s Tyler Parker is bearish on Apex Legend’s future prospects. The analyst sees sales for the game falling to $275 million in FY2020. This is well below EA’s guidance of $300 million-$400 million in FY20 sales.

However, Parker may be discounting the potential of Season 3. Baird’s Colin Sebastian is more optimistic, and agrees with Lango’s assessment of the new season release. Sebastian is confident in his above-consensus revenue estimates.

With EA’s future growth up in the air, is the current valuation justified? Let’s take a closer look at valuation, and see whether Electronic Arts stock is a bargain relative to its peers.

EA Stock Valuation Remains High

Electronic Arts stock currently trades at a forward non-GAAP price-to-earnings ratio (forward P/E) of 21.07 . The company’s current enterprise value/EBITDA ratio is 19.4.

This valuation is in line with competitor Activision Blizzard (NASDAQ:ATVI). ATVI’s non-GAAP forward P/E is 25.3. Its EV/EBITDA ratio is 17.3. Smaller competitor Take-Two Interactive (NASDAQ:TTWO) trades at a higher valuation. TTWO shares trades for 26 times non-GAAP forward earnings and has an EV/EBITDA ratio of 46.1.

In my prior analysis, I believed Electronic Arts’ premium to be justified. In that article, I compared the company to Disney (NYSE:DIS), as both companies trade at high valuations due to their intellectual property assets. But Disney’s stable of franchises is much more expansive than EA’s. EA may have strong franchises with Madden and FIFA, but for games such as Star Wars they are dependent on companies like Disney for licensing.

The other key concern I have for valuation is whether or not EA can materially boost margins. As video games move from physical to digital distribution, operating margins, in theory, should go up.

For FY2020, EA estimates digital sales will be $4.2 billion, versus $1.2 billion in physical sales. Physical sales in FY19 were also $1.2 billion. With declines in physical product sales slowing down, it could be years before distribution moves to entirely digital.

Bottom Line: Skip on EA Stock

EA may have a strong business model. But Electronic Arts stock remains overvalued. The company trades in-line with its video game publishing peers, but those valuations themselves may be inflated. The company projects low growth over the next few years. While mid-single-digit revenue growth is nothing to sneeze at, it hardly justifies the current valuation of EA stock.

EA is too big to be acquired, even by a behemoth such as Disney. But the stock trades at a valuation that implies someone will do just that.

So what’s the verdict with EA stock? Avoid. I do not believe Electronic Arts stock is a strong short candidate. Their stable of strong franchises should help preserve sales. But in terms of growth, the company remains challenged. EA needs more “free-to-play” games such as Apex Legends.

The in-game purchase revenue model is the wave of the future. Until EA develops another game-changing franchise, future growth remains up in the air.

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

Article printed from InvestorPlace Media, https://investorplace.com/2019/10/ea-stock-overvalued-may-hold-steady/.

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