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Summary

  • No reason to worry about EA’s conservative guidance: it’s still early in the fiscal year and the video games business is traditionally back-end loaded.
  • EA’s Q1 revenue beat and NPD data suggest that EA is on track to exceed revenue expectations by 5-10% in both FY15 and FY16.
  • Margins can exceed previous highs in view of the group’s impressive opex discipline and rising weight of highly profitable digital revenues in the mix.
  • EA is trading at 18.5x 2015 EPS, while earnings growth is expected well above 20%.

Another quarter, another beat

We have been touting Electronic Art's (NASDAQ:EA) EPS upside potential since the beginning of the year and, once again, the company delivered impressive Q1 figures ($0.19 EPS vs. consensus at $-0.04).

Despite the beat, EA guided only in line with the Street for Q2 and left unchanged its FY15 guidance. In our view, there's no reason to be disappointed as we are still early in the year while the video games business is traditionally back-end loaded. EA [and Activision (NASDAQ:ATVI)], which had already guided rather conservatively in the previous quarter, will probably set more aggressive revenue targets when their visibility improves on the second part of the year and specifically on the Christmas quarter.

Despite the slippage of Battlefield Hardline to Q4 from Q3 (holiday season), we believe that EA is well on track to exceed revenue expectations by 5-10% in both FY15 and FY16. Indeed, recent NPD data have been extremely encouraging, with a stronger-than-expected recovery in physical retail game sales in the U.S. (from -27% in March to +57% in May boosted by the release of Watch Dogs and -3% in June). Interestingly, NPD commented that PS4/Xbox One game sales were up 40% relative to PS3/Xbox 360 sales over their first 6 months of availability: this points to a much stronger-than-expected take-off of the next gen cycle, giving confidence in coming quarters.

Margins can probably exceed previous highs

Analysts are now expecting operating margins of 21.5% and 23.5% respectively in FY15 and FY16. Assuming EA gets back to its previous margin high (26% in 2004), we believe that the combined top-line and margin upside would spark EPS upside around 20%.

This is great…But we believe that margins can exceed previous highs in view of the group's impressive opex discipline and rising weight of highly profitable digital revenues in the mix (>60% of Q1 revenues). A margin close to 30% is achievable in our view.

In conclusion, we remain bullish on the stock, as we believe that the valuation does not reflect EA's earnings power. After the strong performance year-to-date and EPS upgrades, EA is trading at 18.5x 2015 EPS, while earnings growth is expected well above 20%.

Source: Electronic Arts: Conservative Guidance Leaves Scope For Major 2nd Half Upside