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Keywords - profits ahead of analyst expectations

Nicholas Hyett, Equity Analyst | 24 November 2020 | A A A
Keywords - profits ahead of analyst expectations

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Keywords Studios plc Ordianry Shares 1p

Sell: 2,992.00 | Buy: 2,998.00 | Change -38.00 (-1.25%)
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In a brief trading update Keywords said that full year revenues are expected to be in line with market expectations of €367m. That suggests year-on-year growth in the region of 12.4%, and reflects good underlying demand partially offset by coronavirus related constraints.

However, underlying profits after tax are expected to come in at around €52m for the year, up 27.1% year-on-year and some way ahead of current market expectations. That reflects underlying margin improvements thanks to operational leverage, good cost control and the reduction in some costs (like international travel) driven by the coronavirus outbreak.

The shares rose 4.2% in early trading.

See the latest Keywords Studios share price, charts and how to trade

Our View

Gaming is one of the few sectors that's benefited from the lockdown - as increasingly large numbers of us looked for entertainment at home.

But as a provider of services to game developers, rather than owners of games themselves, Keywords hasn't seen the stellar revenue boost in the short term that game owners have enjoyed. However, looking to the second half of the year and beyond, things could be different.

Now that the group and its clients are up and running remotely and back in the office where needed (audio and testing are service lines that deliver remotely), it's well placed to service the increased demand for gaming content. The long awaited launches of PlayStation 5 and Xbox X Series are expected to boost demand too, and smaller developers will also be looking to cash in on recent market growth.

Further lockdowns will still pose challenges, but Keywords' size and reinforced balance sheet mean it should be more than a match for them.

Longer term improving underlying profitability remains a key focus though. Lower travel and marketing costs have nudged margins higher so far this year, but we'd like to see evidence of more permanent progress. Early signs are that the group should be able to deliver a shift towards historic operating margins by the end of 2021.

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. Luckily the group's recent additions look more like the former and should add to the group's ability to service new content demand.

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. The combination of rising revenues and rising margins would be a heady one for profits. However, with the stock trading on a fairly intimidating PE ratio that's well above its long-term average, the price of failure will likely be high.

Keywords Studios key facts

  • Price/Earnings ratio: 38.9
  • Average Price/Earnings ratio since listing: 27.0
  • Prospective dividend yield (next 12 months): 0.1%

All ratios are sourced from Refinitiv. 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.

Register for updates on Keywords

Half Year Results - 17/09/20

First half revenues of €173.5m were 8% higher than last year, excluding the effect of acquisitions. Despite coronavirus disruption underlying margins nudged higher and underlying profit before tax was 18% ahead of last year at €21.7m.

Trading in the second half has started well with growth across all service lines and margins are expected to improve further. The group expects demand to be boosted by upcoming console launches.

Keywords plans to resume its dividend policy in 2021.

All but one of the group's seven service lines reported organic growth over the first half, despite initial operational disruption from lockdowns and studios closure. The Localization service line was impacted by delays elsewhere and saw revenue fall. Overall revenue growth was concentrated in Game Development which saw revenues rise by just over 30%, and is now Keywords' largest service line.

Overall operating costs increased by 9.1% to €32.1m, but the group reported a reduction in certain costs including travel and marketing due to lockdowns - which boosted margins.

Keywords acquired Coconut Lizard (game development studio) in June for €1.7m, bringing total acquisition costs for the first half to €2.5m. So far in the second half the group has acquired west coast game developer, Heavy Iron, and European marketing business Maverick Media.

Free cash flow generated by the group was €11.6m, compared to a small cash outflow last year. That reflects higher profits and €3.4m of COVID-19 related government subsidies largely from the Americas.

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 €110m share placing and organic cash generation.

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 Refinitiv. 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.