The video game industry is going through a downcycle in 2022. A combination of restricted supply for new gaming consoles and a reversion to long-term trends has industry spending slightly down in 2022. For example, the NPD Group estimated that in the third quarter, total video game spending in the U.S. was down 5% year over year.
But not all gaming companies are feeling the crunch equally. Enter Electronic Arts (EA -0.31%), a leading sports and live-services game publisher that continues to put up consistent financial results. Here's why Electronic Arts deserves a spot in your portfolio today.
Fiscal Q2 earnings: Consistency
EA reported its fiscal 2023 second-quarter earnings on Nov. 1. Due to the timing of game launches, its net bookings (the revenue equivalent metric for video game companies) were down 2% year over year in constant currency to $1.75 billion. Taking a longer view, bookings over the last 12 months were up 4% year over year to $7.38 billion and up 32% from two years ago. Clearly, EA is not feeling much of a hangover from the 2020 quarantine boost.
Driving this consistent top-line growth are multiple game franchises, the most important being FIFA Soccer. The simulation franchise is one of the most popular games every year. FIFA 23 debuted in September and saw 10% growth in units sold over last year's version (based on the first four weeks of release).
So EA's sales look consistent, but what about profitability? The company has been strong in that department as well with trailing-12-month operating cash flow of $1.79 billion. Operating cash flow can be a better earnings metric than net income for a gaming business because of the accounting standards for deferred revenue that can muddy the income statement. These cash-flow numbers have held steady since 2017 and show the durability of EA's diversified gaming model.
Data by YCharts.
Large pipeline of games
At the same time, while EA's profitability has held steady over the last few years, it has struggled to grow in line with bookings. At first glance, investors might be concerned EA's business is not as profitable as it once was. When looking at its guidance for the fiscal year that ends in March 2023, management is actually guiding for operating cash flow to decline from the previous year to a range of $1.60 billion to $1.65 billion.
But I think investors who are pessimistic about EA's profitability are missing the big picture. Over the next three years, EA's cash flow should inflect higher due to the huge pipeline of games it's working on. These games require upfront development and marketing costs but don't earn any revenue until the games come to market. That can make profitability choppy when looking at arbitrary timeframes, which is what's happening this fiscal year.
EA's pipeline is not entirely public, but we do know it's working on a return of its popular college football game, a Dead Space remake, Mass Effect, Need for Speed, Skate, a Lord of the Rings mobile game, and multiple titles for the Star Wars and Marvel franchises. This is on top of investing in its existing live services games like FIFA Soccer, Madden NFL, The Sims, and Apex Legends.
The big risk here is that these releases fall flat, which can always happen in the entertainment business. But if the company can execute, it's highly likely EA's annual cash flow will be much higher a few years from now.
Valuation plus buybacks
At today's price, EA stock has a market cap of just over $36 billion. Compared to the midpoint of its full-year fiscal 2023 operating cash flow guidance, that gives the stock a price-to-operating-cash-flow (P/OCF) multiple of 22.2, which doesn't look cheap for a low-growth business.
Data by YCharts.
However, investors should remember that this year's cash flow is depressed, and the stock's cash-flow multiple should come down significantly over the next few years. Management will likely continue returning capital to shareholders through share repurchases, which have helped reduce EA's outstanding share count 10% in the last five years.
Taking all these factors into consideration, I still think EA stock is an easy buy at these prices.
