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Keywords - Sales tick up despite Covid-19 disruption

Nicholas Hyett, Equity Analyst | 4 August 2020 | A A A
Keywords - Sales tick up despite Covid-19 disruption

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Keywords Studios plc Ordianry Shares 1p

Sell: 2,612.00 | Buy: 2,620.00 | Change -32.00 (-1.21%)
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In a brief trading update ahead of interim results Keywords said it expects half year revenues to come in at €173.5m, with sales up 8%, excluding the effect of acquisitions. Underlying profit before tax is expected to be 18% ahead of last year at €21.7m.

At the end of the half the group had net cash of €101m, up from €17.9m net debt at the start of the year. That reflects the proceeds of a £100m share placing and organic cash generation.

The shares were broadly flat following the announcement.

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Our View

Keywords has weathered the current disruption rather well, moving over 6,000 staff to working from home in pretty short order.

Gaming is one of the few sectors that might have benefitted from the lockdown - as increasingly large numbers of us were looking for entertainment at home. However, as a provider of services to game developers, rather than owners of games themselves, that cash hasn't necessarily found its way through to Keywords yet. In fact one survey suggests 29% of gaming service providers fear insolvency if the current crisis were to drag on for an extended period.

Fortunately Keywords' size and a recently reinforced balance sheet means we don't think the group's at risk. While there has been disruption in some product lines, particularly audio and testing, that's subsiding and the group's managed to deliver organic revenue growth.

We do have some questions about underlying profitability though - especially given the extra costs incurred shifting staff to working from home. We'll have to wait until September's half year results for a better idea of what's happening there though.

In the meantime management have taken advantage of the group's higher share price, currently trading on a PE ratio of 41.7, to issue £100m of new shares. The extra cash is intended to provide the firepower to snap up struggling independent rivals.

Acquisitions have long been a key part of the group's strategy to become the go to provider of outsourced services to the computer games industry. Buying opportunities at lower prices would certainly be welcome, but discipline is still important and a careless buying spree could be damaging. Something we'll be keeping an eye on.

Overall we think Keywords has performed well. Revenues have continued to improve and trends emerging from the current crisis probably play in the group's favour. However, with the stock trading on a fairly intimidating PE well above its long-term ratio average we're more cautious going forwards.

Keywords Studios key facts

  • Price/Earnings ratio: 41.7
  • 5 year average Price/Earnings ratio: 29.4
  • Prospective yield: 0.1%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Trading Update

Keywords reported revenue growth of 30.2% in 2019 to €326.5m, with acquisitions boosting underlying organic growth of 15.5% during the year. However profit before tax fell 21.4% to just €17.4m, reflecting lower margin acquisitions, increased investment in operational capabilities and a significant increase in share option related expenses.

Almost 75% of employees are now working from home as the group looks to minimise coronavirus related disruption. Demand has increased for many services but, given the circumstances, the board has decided not to pay a dividend this year.

Keywords completed 8 acquisitions during the year, across Game Development, Marketing and Audio Services. The total cost of acquisitions during the year was €19.6m, with a cash cost of €13.1m.

All but one (Player Support) of the group's seven service lines reported organic growth during the year. However, growth was concentrated in the Game Development and Functional Testing divisions, which both saw revenues grow by more than 30%.

Overall operating costs increased faster than revenues, with margins shrinking as a result. That largely reflects increased investment in operational capacity to support the enlarged group, with margins expected to improve going forwards.

Below the operating level Keywords incurred costs of €4.3m integrating past acquisitions, while share option related costs more than doubled to €9.8m with most (€9m) relating to employees below director level.

Keywords generated free cash flow, after integration costs, of a little under €10m. However, acquisition costs meant net debt rose €17.5m to €17.9m. That equates to 0.4 times 2019 cash profits.

Given the coronavirus disruption the board is not providing financial guidance for the current year.

Find out more about Keywords Studios, including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.