EA: Hilliard Ups to Buy; Sell-Off ‘Excessive’

Hilliard Lyons‘s Jeffrey Thomison today raised his rating on shares of Electronic Arts (EA) to “Long Term Buy” from Neutral, writing that the fall-off in the stock of late is “excessive,” but that EA will be “a more efficient, more profitable company in the next few years.”

The upgrade follows EA’s fiscal Q4 report a week ago, which offered a year outlook that sent shares skidding and prompted at least one downgrade.

Shares are down 4% since the 7th, and down almost 31% this year. The stock is off 8 cents, or half a percent, at $14.31.

Thomison thinks the company’s proven packaged franchises, such as “Madden NFL” and “FIFA” soccer should continue to provide a foundation for the business. Mobile and social gaming offer higher growth potential, and the “Star Wars” game franchise should see stabilization in its subscriber base after recent declines, he thinks, which have been a source of concern for investors.

Regarding Star Wars, Thomison notes management said on the Q4 call that subscribers at the end of April totaled 1.3 million, which appeared to be down from about 1.7 million in March. Thomison thinks it’s important not to expect too much from such subscription franchises, as they are a tough business:

We believe the industry can likely support only a few major games of this business model. The industry�s largest online, multi-player, subscription-based game is World of Warcraft from Activision
Blizzard, a game that has also seen weakness in the subscriber base over the past several quarters. World of Warcraft recently had 10.2 million subscribers. Although SW:TOR is profitable and is expected to
grow over time, we will keep our expectations for the game in check, particularly in an industry environment that has been sluggish for the majority of the past three years.

As regards the smaller slate of first-line titles this year, Thomison thinks games such as “Medal of Honor: Warfighter” can still offer decent sales: “Although the slate is pared down compared to past years (focusing on a smaller number of franchises), we consider most upcoming titles to have meaningful sales potential due to established followings and/or large-scale marketing efforts.”

The outlook for this fiscal year, which ends in March of 2013, was “disappointing,” writes Thomison, but there’s still the chance that margin improvement will make things look better, he thinks:

Non-GAAP earnings are expected in the range of $1.05-$1.20, with the mid-point representing growth of 32% from FY12. However, we feel revenue guidance was a bit underwhelming at $4.3 billion, or less than 3% above FY12. This suggests substantial margin improvement is needed to achieve the EPS target. We believe this is possible due to expected growth of the higher margin digital segment, a relatively small increase in operating expenses, and some benefit from share repurchases.

Thomison is modeling EPS of $1.10 for this year, just below the consensus $1.12.

At just ten times fiscal 2013 estimated EPS, after subtracting cash, the stock’s valuation is below the 13 to 28 range of the forward P/E over the last two years, he notes.