For Immediate Release
Chicago, IL – May 5, 2020 – Zacks Equity Research Shares of Electronic Arts EA as the Bull of the Day, Boot Barn BOOT asthe Bear of the Day. In addition, Zacks Equity Research provides analysis on Alphabet GOOGL, Facebook FB and Twitter TWTR.
Here is a synopsis of all five stocks:
Bull of the Day:
Electronic Arts, aka EA, is unquestionably ‘in the game’ during this global pandemic. Casual and dedicated gamers alike are glued to their screens across the globe, providing a rare tailwind to this video game powerhouse. Analysts have been increasing their EPS estimates for the next few years, pushing EA into a Zacks Rank #1 (Strong Buy).
EA has been a dominant player in video game development since the inception of modern video games in the 80s. EA is best known for its iconic life simulation game The Sims, as well as its lineup of leading sports games like FIFA, Madden, and NHL, which are released annually. The firm has a broad portfolio of world-renown video games that continue to drive its topline.
EA and its innovative management team have been successful in transitioning from physical video games to a digitally-driven & subscription-service model. EA still relies on new video game releases for revenue growth, but EA’s live services now makeup over 50% of the company’s sales and are expected to be a primary topline driver moving forward. These live services include subscription services that allow gamers to play a select catalog of games for a monthly fee as well as esports.
EA is a major player in esports, a new digitally competitive ‘sport’ where gaming enthusiasts can watch their favorite gamers compete in the video games that they know and love. According to Influencer Marketing Hub, this fast-growing industry is expected to be worth $1.65 billion by next year, with a compounded annual growth rate of over 27%. EA is well-positioned to corner a sizable portion of this market with its essential esports games: Apex Legends, FIFA, Madden NFL, as well as globally sponsored events & competitions.
The stay-at-home initiative is conditioning our society to rely on digital entertainment like video games for a daily release. I suspect that this uptick in gaming will continue into the post-pandemic world.
We are on the verge of a new wave of mobile gaming, which will be driven by cloud technology. 5G is going to be the primary catalyst that makes this form of gaming possible, with its hyper-fast connectivity. EA is partnering with Google Stadia to make its games available through Stadia’s cloud platform. I suspect that EA will be partnering with more cloud gaming innovators like Microsoft and Nvidia as high-quality mobile gaming gains traction.
Societies’ new normal will be playing more video games, and the next generation of gaming consoles that are anticipated to be released in the 2020 holiday season gives me even more cause to be bullish on EA long-term potential.
EA has a volatile top and bottom line that tend to be cyclically correlated to game releases, but the rise of its live services segment should curb some of the volatility into consistent growth. EA Sports’ annual versions of FIFA, Madden, and NHL provide some reliability in sales figures each year, but the yearly improvements are becoming increasingly marginal.
This enterprise is well-capitalized with $5.6 billion in cash & equivalents, making up more than its total liabilities on the balance sheet. The company has very little debt on the books and robust growing cash flows that are more than enough to finance its innovative operations and attractive investment opportunities.
Tonight’s Earnings Release
EA is releasing its March quarter earnings after close tonight. This should provide us with a clearer picture of how the company has benefited from the increased engagement and whether this pandemic tailwind will continue in the post-pandemic world.
I would be hesitant to put a position on these shares before the quarterly results are released tonight because of the stock’s recent run-up. Investors may be ready to pull profits off the table amid the economic uncertainty.
According to Zacks Consensus estimates, we are looking for an EPS of $0.98 on sales of $1.17 billion, which would represent a YoY decline on both metrics. Focus on management’s discussion of future expectations and investments for clues on where the company is headed. Any direct mention of guidance will likely be the catalyst for any substantial price action if provided.
EA is a robust long-term investment for your portfolio of the future. This company has driven innovation for decades, and I anticipate that it will continue to do so in the years to come. The savvy management team continues to stay ahead of the innovation curve. The next generation of gaming consoles, as well as the rise of esports, should position EA for robust growth in the coming years.
Bear of the Day:
Boot Barn was actually a healthy growing company coming into this pandemic-driven economic slowdown, but this natural disaster triggered a rude awakening for this working-class retailer. BOOT shares have plummeted over 60% for 2020 thus far, as investors price out this stocks potential.
The stock had driven up over 500% since Q4 of 2017 as the company runway of growth kept extending, but unfortunately, it looks like the company may have overextended itself. Analysts have been decreasing their EPS estimates in both the near and long-term, pushing BOOT into a Zacks Rank #5 (Strong Sell).
The Pandemic’s Impact
Just to be entirely transparent off the bat, I am not recommending that you bet against shares of BOOT, I am merely saying these shares may still be in trouble, despite losing most of their value from January.
Boot Barn is retail that sells functional workwear to those in working-class jobs such as construction, manufacturing, oil & gas, electric/plumbing, and agriculture. These are the industries that are seeing some of the most significant employment cutbacks.
This enterprise has a considerable strategic presence in key oil regions around the US, and the massive hit that this industry has taken is going to ripple into Boot Barn’s financials.
Loss of employment and job uncertainty is going to substantially hamper demand for Boot Barn products. It will be years before these industries reach full employment again (if they ever do), and I suspect that this will strain demand for Boot Barn in the coming years.
Boot Barn had been aggressively expanding its western presence with an increasing number of big-box brick-and-mortar storefronts averaging 11,000 square feet. The company currently operates 264 stores in 33 states, representing a 50% storefront increase in the past 5 years. I think they may have overextended themselves. The overhead from its enormous storefronts may be Boot Barn’s undoing.
The business’s paper-thin margins, combined with massive inventory levels, is quite concerning to me. Boot Barn will likely be forced to sell its products at a sizable discount to clear some of its inventory. This will weigh heavily on its already tight margins. I suspect we will see some negative EPS results in the coming quarters.
The company had, in the past, been able to rely on its cash flows to support operations, but I do not believe that this will be possible in the coming quarters. As of December 31st, 2019, Boot Barn had $45 million in cash and will likely need to dig into its revolving lines of credit to maintain operations.
Glimpse of Hope
Boot Barn has a small ecommerce presence (making up just over 15% of its sales), unlike a lot of its cohorts. Boot Barn stores are largely located in rural areas, which are expected to see an increase in brick-and-mortar foot-traffic more quickly than non-rural regions. These two silver-linings could be this retailer’s saving grace, but uncertainty remains high, and I would still stay away from BOOT shares.
This unprecedented global pandemic has been able to turn a seemingly healthy growing company on its head. There is still hope for this rural retailer, but it is up to management to navigate these murky economic waters. For now, I would keep my distance from these shares until we get more color on management’s strategy to get through this highly uncertain period.
Post-Earnings, Which Stock Is Better: Alphabet or Facebook?
Considering the fact that Alphabet and Facebook, like everybody else, are in the middle of a global pandemic, their earnings reports were okay. The current quarter and the quarters thereafter will be more difficult for these companies as a battered global economy struggles to get back into equilibrium.
So what was there in the just-reported quarter (and overall) that can perhaps help us decide whether we might want to buy some shares?
Overall Results Weren’t Too Bad
Alphabet earnings $9.87 (Zacks Consensus $10.40, year-ago $11.90): miss, down 17.1%
Sales $33.707 billion (Zacks Consensus $32.587, year-ago $29.479): beat, up 14.3%
Facebook earnings $1.71 (Zacks Consensus $1.73, year-ago $0.85): miss, up 101.2%
Sales $17.737 billion (Zacks Consensus $17.286, year-ago $15.077): beat, up 17.6%
The primary concern as far as most investors are concerned is regarding the hit to ad revenue and the length of time this weakness may be expected to continue. Since both Alphabet and Facebook have a geographically widespread business that excludes China, they were both impacted by constricted ad budgets.
Ad Revenue Slowed In March
Alphabet’s total ad revenue grew 10% from 1Q 2019. YouTube ad revenues grew 33%, mainly because of very good growth in the first two months of the year that dropped off sharply in March, as brand advertisers cut back significantly, while direct response remained strong. APAC was the strongest region although U.S. and other Americas also grew.
Facebook also grew ad revenue 17% (or 19% on a currency-neutral basis), which is pretty good all things considered.
Asia/Pac was 5 points stronger that the rest. Usage (3 billion MAUs for the first time) and engagement (messaging, voice/video calling) both swelled, offsetting the drop in ad prices toward the end of the quarter.
The mobile newsfeed on Facebook was the biggest driver, due to prior product optimizations and increased engagement.
The company started seeing weakness in the second week of March, primarily from auto and travel operators, which is kind of not surprising. It did however see strength in gaming and what it called “relative stability” in technology and ecommerce (its largest served area). Weakness was more or less evenly spread between large and small players, and across the U.S., Canada, Europe and Rest of World.
Zuckerberg cautioned: “I don't expect that this exact spike in usage will sustain over a longer period of time.”
Both Companies Gained From Businesses Moving Online
In Alphabet’s case, this was reflected in its non-advertising revenue, including its Google Play Store that jumped 30% between February and March, Google Classroom that doubled to 100 million students and educators, an estimated 400% increase in Chromebook demand, its video conferencing software Meet now being used by companies like Twitter.
And of course it was also reflected in the increased use of Google Cloud where revenues jumped 52%, with strength across companies in retail, public sector, healthcare, gaming, media and communications companies, and other sectors for things like network analytics, customer service, demand forecasting, and disease monitoring and control.
More users are looking for businesses on Facebook and Instagram platforms amid lockdowns and shelter-in-place orders. Facebook is making the most of this trend by quickly creating store fronts and facilitating transactions. This helped its small business revenue. The company expects its personalized ad targeting and measurability of ad performance to help it grow its small business roster. It has also sweetened things by offering funding to this group as well as news providers that now have to operate on reduced ad budgets.
The primary driver of both revenue and earnings for Facebook and Alphabet was again advertisements, as the first two months were very strong. When ad revenues dropped off, the other side of the business picked up.
Expenses with an Eye to the Future
In addition to higher traffic acquisition cost and content acquisition cost (mostly for YouTube ad-supported business), Alphabet reported additional depreciation related to infrastructure build and R&D and S&M team building to support the growing Google Cloud business. There was also a provision for expected credit deterioration related to COVID.
Increased depreciation related to its infrastructure build was a factor for Facebook as well, but the 40% increase in its R&D was attributed to AR/VR product development. Facebook’s marketing costs also increased. It also made a provision for expected credit deterioration related to COVID.
Facebook is obviously strengthening its ecommerce and online delivery businesses, while building Oculus, which had a very strong quarter, in an attempt to offset the weakness in ad revenues that is bound to continue. Alphabet is working to improve the Google Cloud business even as several non-ad segments are growing strongly.
Outlooks Show Increased Caution
Alphabet is concerned about the higher level of depreciation, the cost of operating its technical infrastructure, as well as things like customer support and content review in a market where revenues are dependent on economic recovery. So it will be scaling back capex slightly to below 2019 levels and reduce hiring beginning in the third quarter, except in strategic areas. The silver lining management pointed out is that search tends to snap back very quickly once economic activity resumes.
Facebook withdrew revenue guidance for 2020 and lowered total expense target from $54-59 billion to $52-56 billion (including $300 million allotted to date to help the broader community). Still, weaker revenue is expected to result in a negative impact on the 2020 operating margin.
Both companies generate the bulk of their revenue from advertising, which may be expected to remain very weak right through the year. Moreover, while they are both in different stages of diversification and Alphabet is somewhat ahead of Facebook, with the billions coming from cloud, hardware, Play, etc, it’s still unlikely to move the needle for the company if ad revenue falls too far.
While some of its initiatives under “Other Bets” also look encouraging, they’re unlikely to have any material benefit this year. Facebook’s other revenue is miniscule, so doesn’t warrant much of a conversation yet.
But Facebook has signed an exciting new ecommerce deal, wherein WhatsApp will collaborate with India’s Reliance Jio, which has incredible opportunities for the future (I’ll leave that for another day). The business might take off this year too, since Jio is already testing its ecommerce platform.
Also, these are solid companies with huge cash generating potential (and balance sheet cash) that will bounce back quickly when the market does. They won’t be set back too much the way many others will, i.e., they are very low-risk.
That said, my hunch is there’s more room to fall, with further deterioration in results looking forward and especially considering that they’re slightly overvalued now, on most key metrics. So while nobody knows for sure what a stock will do, I’d wait to add position here.
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