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Keywords - strong first half growth

Nicholas Hyett, Equity Analyst | 15 September 2021 | A A A
Keywords - strong first half growth

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Keywords Studios plc Ordianry Shares 1p

Sell: 2,986.00 | Buy: 2,994.00 | Change -44.00 (-1.45%)
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Underlying revenue rose 22.9% to €238.7m, with all segments posting double digit growth thanks to the impact of the pandemic on last year's figures.

Underlying cash profits rose 64.6% to €50.7m, reflecting 1 3.4 percentage point improvement in cash profit margins to 21.2. In addition to better revenue generation, cost savings from remote working and lower spend on travel, business development and marketing fed into this improvement.

Strong demand has continued into the second half of the year, but growth is expected to moderate as the group laps last year's strong performance.

After pausing dividend payments in 2020, Keywords will pay an interim dividend of 0.7p per share, a 20.7% increase from 2019.

The shares were broadly unchanged following the announcement.

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

Our View

As an outsourced supplier to the gaming industry Keywords doesn't rely on the success of individual titles. Instead it benefits from overall industry growth.

It's often said that during the California goldrush the big winners weren't the miners themselves, but those selling shovels. We see Keywords as a purveyor of pickaxes in the digital goldrush that is global gaming - no bad place to be while the boom lasts.

After some initial disruption (audio and testing are difficult service lines to deliver from home) the group and its clients are up and running for the most part. Revenue growth has been strong so far this year, though it could start to temper in the second half due to difficult comparisons.

The group is upbeat about the potential for increased demand to last beyond the pandemic. A host of new games are expected following the launches of the PlayStation 5 and Xbox X Series, and smaller developers will be looking to cash in on recent market growth as well as hold on to new gamers.

We're particularly impressed with the improvement in profitability - with profit growth comfortably outpacing revenues. However, temporary tailwinds like lower travel and marketing costs have nudged margins higher, and we're keen to see higher margins sustained going forwards.

Despite several acquisitions, significant free cash flow means the group has a sizeable chunk of cash sitting on the balance sheet. That will no doubt fund future deals, long a key part of the group's strategy to become the go to provider of outsourced services in the industry. However, discipline is still important and a careless buying spree could be damaging. Luckily recent additions look to be at reasonable valuations and should add to the group's ability to service new content demand.

Speaking of which, Keyword's flagged an inability to find highly skilled workers to fill out its Game Development roster. This is keeping the group from taking full advantage of strong demand for its services. The result will be wage inflation and higher costs for Keywords, which may or may not pass through to customers. This isn't make-or-break for performance, but it could temper profit growth somewhat moving forward.

Overall, we think Keywords is in a strong position. The departure of CEO Andrew Day adds a layer of uncertainty that could cause some near-term volatility, but doesn't change the overall story. Revenues have continued to improve and the trends emerging from the current crisis probably play in the group's favour. Keyword's strengths are reflected in a fairly lofty valuation, showing confidence in the group's end market, but still demands the group delivers near perfect execution going forwards.

Keywords Studios key facts

  • Price/Earnings ratio: 43.8
  • Average Price/Earnings ratio since listing (2013): 28.5
  • 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.

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Half Year Results

Underlying revenue for Art Creation (9.5% of revenue) was up 25.4% to €22.7m. This segment added new studios in China, Bangalore and Manila and the acquisition of AMC meant it entered Romania for the first time. The segment is expected to continue delivering strong growth through the second half.

Marketing (9.7% of revenue), is being broken out as a standalone division for the first time and posted underlying revenue of €23.2m, up 50.6%. This reflected clients' shift toward online advertising in the absence of large industry events. Growth is expected to moderate in the second six months of the year, due in part to the difficult comparisons from last year's strong performance.

Despite recruitment challenges making it difficult to service strong demand, Game Development (26.5% of revenue) saw underlying revenue rise 15.5% to €63.3m. The second half could see costs rise from wage inflation as the group looks to attract highly skilled workers. The division will also continue to seek out potential strategic acquisitions to meet customer demand.

Underlying revenue in Audio (11.9% of revenue) was up 36.4% to €28.3m, reflecting the reopening of recording studios closed during lockdowns and new remote solutions. The group expects growth to moderate somewhat in the second half, but its investment in stable remote services means Covid-related headwinds will have less of an impact.

The covid related disruption during the same period last year contributed to underlying revenue growth in Functional Testing (18.1% of revenue) of 24.3% to €43.3m. As this segment works with later-stage game development projects, the group is expecting activity to pick up in the second half as covid-related delays pushed back development timelines.

Localization (9.7% of revenue ) reported underlying revenue of €23.2m, a 10.7% increase. This reflected the restart of projects delayed in 2020 due to the pandemic. Growth in the second half is expected to continue but delayed projects means the typically higher seasonal activity could be held back.

Localization Testing (5.3% of revenue) saw underlying revenue improve 19.6% to €12.6m, helped by easier comparisons against last year's figures. As with Localization, delays could hold back revenue growth somewhat.

Helped by the rising number of gamers, Player Support (9.3% of revenue) had a 17.7% increase in underlying revenue to €22.1m.

The group has made four acquisitions so far this year, for a maximum consideration of €105m.

The group's net cash position fell to €84.1m from €102.9m at year-end, reflecting increased acquisition costs and exchange rate movements. Free cash flow rose by €12.2m to €23.8m, the result of higher reported profits.

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.