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Electronic Arts Stock Investors Benefit from its Excellent Free Cash Flow

Electronic Arts (NASDAQ:EA) stock is worth buying due to its huge free cash flow (“FCF”). EA just reported its September quarter earnings and cash flow and it was stellar. Using a metric called the FCF yield, EA stock is deeply undervalued.

Electronic Arts Stock Investors Benefit from its Excellent Free Cash Flow
Source: Shutterstock

Electronic Arts is one of the few reporting companies, like Amazon (NASDAQ:AMZN), that provides investors with FCF data on a trailing 12-month basis. This is usually typical of companies that have constant and high FCF.

On Oct. 29, 2019, EA reported that revenue rose 4.8% year-over-year for the quarter ending Sept. 30. More importantly, its FCF skyrocketed 20%.

For example, Electronics Arts offered the table above that shows its operating cash flow on a trailing 12-month basis, along with the related capex spending. What’s evident here is that in its most recent quarter, EA produced $1.7 billion in operating cash flow over the past 12 months, up 20% YoY. Its capex spending was also up 20%.

Since FCF is equal to operating cash flow minus capex spending, the total FCF was up 20% YoY. I put together the following table which shows the ongoing FCF calculations.

So you can see that in just about every quarter this past year, Electronic Arts had growing free cash flow. EA truly is an FCF machine.

This is important when it comes to valuing EA stock.

Cheap Compared to Peers

If you compare Electronic Arts market cap to its FCF you can derive what is called its FCF yield. This shows how well the market is currently valuing the amount of FCF that the company is producing.

After all, FCF is what is used by most companies to pay dividends and to buy back their stock. EA does not pay a dividend. But it does use its FCF to reduce its shares outstanding each quarter.

Evident in the table above is that EA buys back about $305 million worth of shares each quarter. In other words, it is using 19-20% of its FCF each quarter to reduce its shares outstanding. That helps create scarcity in EA stock available to the public and also increases earnings per share. Both of these effects help push up Electronic Arts stock price.

To derive the FCF yield comparisons with other stocks I decided to first look at Electronic Arts’ forward guidance.

Electronic Arts Earnings Guidance

Electronic Arts forecast that its revenue for the year ending March 2020 will be $5.4 billion. Its operating cash flow is also expected to be $1.63 billion.

Based on this, I can calculate its free cash flow expected for the year. Since EA’s average spending on capex is about 7.5% of its operating cash flow, the expected FCF will be $1.5 billion.

Now since Electronic Arts has a market value of $28.5 billion, its FCF yield is 5.3%.

But how does that compare with other gaming stocks?

EA Value Upside Based on its Peer’s FCF Yield

I decided to look at four companies: Tencent Holdings (OTCMKTS:TCEHY), Activision Blizzard (NASDAQ:ATVI), Ubisoft (OTCMKTS:UBSFY), and Take Two Interactive (NASDAQ:TTWO).

You can see from the table here that Electronic Arts has a higher FCF yield than its peers. That means that it is cheaper than comparable stocks.

For example, that is like when a stock has a higher dividend yield than other stocks in its group. It is more attractive and cheaper.

So how much cheaper? And what would Electronics Arts stock be worth if it had the lower peer average FCF yield?

That computation is in the table at the right. It shows that Electronic Arts stock is worth $33 billion, or $111.11 per share. That is 18 % higher than its price today of $94.11 per share. And that makes sense since EA’s FCF yield is 18% higher than its peers’ FCF yields.

EA Stock has an Attractive Total Yield

Electronic Arts produces regular and higher free cash flow each quarter. Millennials really like gaming. This means higher cash profits for Electronic Arts. EA stock is cheaper than its peers using FCF yield as a measure.

Moreover, Electronic Arts consistently buys back about $1.2 billion of its shares in the market. Since EA has a market value of $28.5 billion, this gives it a high total yield of 14%. That figure is derived by dividing $1.2 billion by $28.5 billion. That return of capital to shareholders is a very attractive total yield.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks, which includes both high dividend and buyback yields. In addition, subscribers a two-week free trial.


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