© Reuters. Electronic Arts: An Expensive Cash Cow
Electronic Arts (NASDAQ 🙂 is a leading global provider of digital interactive entertainment specializing in the development, marketing and publishing of video games.
Electronic Arts produces and owns the rights to some of the most famous and best-selling franchises such as FIFA, Madden NFL, Battlefield, The Sims, and several others.
The company has grown to a $ 38.1 billion giant while management recently began accelerating capital returns to shareholders. I am optimistic about the stock. (See EA stock charts on TipRanks)
A cash flow machine
Electronic Arts manages a diversified portfolio of franchises, each targeting different audiences, providing the company with multiple sources of cash flow.
This allows for a dispersed timeframe for its games to be released, which means consistent revenue. The gaming industry is subject to seasonality, which the company has defused.
In addition, economies of scale work significantly in favor of Electronic Arts, resulting in significant profitability. The cost of a studio remains fixed, regardless of whether a game sells a few thousand or a few million copies.
As Electronic Arts’ player base has grown over the years, the company has gradually expanded its gross margins, which are currently around 73.4%. The margins are also supported by the trend towards digitally shifting retail sales, which saves the retail-related intermediate costs.
With such high gross margins, the company has been consistently highly profitable which, along with its ability to generate consistent sales, makes it a cash cow among its competitors.
The company is able to scale its current stocks while maintaining a stable and relatively inexpensive CAPEX. For this reason, the majority of the operating cash flow sinks into free cash flow.
The business model is not capital intensive, so management can leverage the company’s large free cash flow to develop a healthy balance sheet while giving a significant stake back to shareholders.
Return on investment, valuation
Electronic Arts management has gradually begun to return an increasing portion of its excess cash flow to its shareholders. In the past four quarters, the company repurchased approximately $ 1.16 billion of its common stock.
Additionally, Electronic Arts introduced a quarterly dividend about a year ago, which is now a tiny 0.5%. The return isn’t that meaningful right now, but the dividend has the potential to grow significantly in the future.
At an annualized rate of $ 0.68, that implies a payout ratio of just over 10% based on the consensus EPS estimates of $ 6.61 for the year.
With earnings set to continue to grow as the video game industry continues to grow, the stock appears to be very reasonably valued.
With a forward P / E of 18, the stock is trading at the lower end of its historical range. Hence, it likely provides an enticing entry point for investors.
After all, the company reported $ 6.1 billion in bookings in its latest results, suggesting that sales and profits should continue to grow as it moves forward.
Wall Street’s opinion
In terms of Wall Street, Electronic Arts has a consensus rating of strong buying based on 16 purchases, three holds, and zero sales assigned in the past three months. At $ 173.13, EA’s average target price implies 29.4% upside potential.
Disclosure: Nikolaos Sismanis had no position in any of the securities mentioned in this article at the time of publication.
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