“Armchair Trader Series” Recommendations
- Week Beginning -
Monday, August 31, 2020

by Ian Harvey

IMPORTANT NOTE: This is a recommendation and individual members can use their own discretion as to when to enter or exit!

You may also wish to read Stock Options Made Easy Trading Philosophy

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"Trading Capital Management"



Option Trade – Electronic Arts Inc. (NASDAQ:EA) Calls

Thursday, September 03, 2020

** OPTION TRADE: Buy EA DEC 18 2020 150.000 CALLS at approximately $7.35 (Up to $7.80).

Place a pre-determined sell at $14.70.

Also include a protective stop loss of $3.00.

The leaders in video games are experiencing tremendous momentum so far this year with people at home during the pandemic. The wave of new players that has formed sets up Electronic Arts Inc. (NASDAQ:EA) for a strong 2020, especially when the new console generation kicks off this holiday season.

Electronic Arts might be one of the better values among the industry leaders right now. It has a forward price-to-earnings ratio of 26 times the consensus earnings estimate for fiscal 2021. That is in line with Activision Blizzard (NASDAQ:ATVI) and much lower than Take-Two Interactive (NASDAQ:TTWO).

Market researcher Newzoo forecasts the video game industry to grow approximately 25% to $200 billion by 2023. That's around $40 billion of incremental spending on games that will surely find its way to popular franchises owned by Electronic Arts, such as Madden, FIFA, The Sims, Battlefield, licensed Star Wars games, the battle royale shooter Apex Legends, and other titles EA may release.

Electronic Arts beat expectations in its first quarter of fiscal year 2021 with strong revenue and record player engagement, and with a handful of additional games slated for release this year, the company is expected to keep up the pace.

Electronic Arts posted a strong quarter not only because more people were at home to play new games, but also because the company has managed to reel in players and keep them paying to play even longer than before.

DLC and live services now account for more than half of Electronic Arts's net bookings, and if the past quarter has proven anything, it's that players are still willing to shell out money for premium content in games they love to play.

The Report.....

On July 31, Electronic Arts reported that 1Q revenues grew 20.7% to $1.46 million year-on-year, beating the Street consensus of $1.05 billion. The company’s non-GAAP EPS of $1.42 also compared favorably with $0.25 reported in the year-ago quarter, surpassed Street estimates of $0.79.

The Pandemic Effect.....

Sheltering in place fueled significant growth in live services across EA's games last quarter. Live services revenue jumped 61% year over year to $1.1 billion, which includes in-game spending on extra content, subscriptions, and advertising.

This performance was driven by "tens of millions" of new and returning players across the EA network of games, as CEO Andrew Wilson explained on the fiscal first-quarter conference call in late July. While in the near term, management remains uncertain about how long these high engagement levels will continue, Wilson said EA's games are serving as social networks as players compete with others online through multiplayer game modes.

"Our EA SPORTS live services are acting as social networks for sports fans around the world, and the strength of those connections will grow as real sports seasons return," Wilson said. "Players in our communities for The Sims, Apex, Star Wars and more are building relationships through our games, and we expect them to be with us for a long time to come."

Its unlikely EA will continue to post huge advances in its live services business every quarter going forward, but it’s clear Wilson expects some of these new players to stick around and contribute to EA's growth.

Influencing Factors.....

Electronic Arts expects future revenue to continue to grow, with little sign of demand weakening. 

Electronic Arts has been able to deliver 30 new content updates for its console and PC titles during the recent quarter while employees were working from home. Most of EA's employees will continue working from home through the end of the calendar year. This is an important advantage in an environment like this when major Hollywood movies have been delayed and people will be looking for alternative sources of entertainment.

Electronic Arts is releasing 14 titles over the course of the year, and at this point, there are only five games left for launch. A number of these titles are in-house console/PC games, but some of them are mobile games, and others are produced by indie studio partners. Players highly anticipate the release of Madden NFL 2021, Star Wars: Squadrons, UFC 4, FIFA 2021, and NHL 2021.

Furthermore, the next generation of consoles is expected to begin release at the end of this year or the next, which should renew interest in soon-to-be released Electronic Arts titles, as well as current games that will still work on the new systems. This could energize full game sales even more.

Another advantage EA has is cash. It ended the last quarter with $5.9 billion in cash and short-term investments and very little debt. Given that hefty war chest, rumors are flying that EA and Activision are the likely bidders for AT&T's (NYSE:T) Warner Bros. Games division, which has an estimated value approaching $4 billion.

Whether or not EA ends up with Warner Bros. Games, it has the cash to either initiate a dividend or make an acquisition that increases the value of the company, particularly within its mobile business.

Going Forward.....

So assuming that Electronic Arts successfully launches its next games in the third and fourth quarters, total net revenue for the next year should increase in line with its guidance of $5.62 billion -- a 1.6% increase from the year before.

The coronavirus pandemic has prompted many players to return to in-home entertainment, and the renewed interest should not decrease any time soon. With the company's focus on premium content extending revenue from each product over time, there is plenty of reason to think that this video game stock will continue to grow in the mid- to long-term future.

Analysts Thoughts.....

Needham analyst Laura Martin has a “buy” rating on video game publisher EA stock. On August 11, the analyst raised her target price by $15 to $165. Based on current prices, the potential upside over the next 12 months is 18%.

Needham analyst Laura Martin wrote in a note that Electronic Arts’ “ongoing pivot toward annuity revenue streams as well as the rapidly accelerating video game industry growth with higher Lifetime Customer Value, or LTV, during the COVID-19 outbreak.” Martin added that the company is “benefiting over the near and the long-term from the rapid rise in hours played, more new games tried, higher in-game spending, and limited competition from live sports during the pandemic.”

The time spent playing has a high correlation to in-game spending, which should boost the company’s results in fiscal 2021, “so long as shelter at home orders persist,” she said. 

The annual release of FIFA and Madden sports games represents an annuity stream business that has a well-established installed base of annual and predictable users, Martin said. 

This lowers the risk for Electronic Arts compared to its hit-driven video game competitors, while its hit titles and the ongoing shift toward digital downloads and uncapped in-game digital purchases provide upside, the analyst said. 

“Finally, we appreciate EA’s licensed IP strategy, which outsources its marketing costs to the sports leagues and film companies that own the underlying IP.”

Several equities analysts have recently commented on the company…..

  • Oppenheimer upped their price objective on Electronic Arts from $125.00 to $150.00 and gave the stock an “outperform” rating in a research note on Tuesday, July 7th.
  • JPMorgan Chase & Co. reissued an “overweight” rating and issued a $150.00 price target (up previously from $127.00) on shares of Electronic Arts in a research note on Friday, July 31st.
  • UBS Group increased their price target on Electronic Arts from $126.00 to $170.00 and gave the stock a “buy” rating in a research note on Friday, July 31st.
  • Finally, Stephens upped their price objective on Electronic Arts from $130.00 to $145.00 in a report on Friday, June 26th.

Currently, the Street has a cautiously optimistic outlook on the stock. The Moderate Buy analyst consensus is based on 18 Buys versus 8 Holds. The average analyst price target of $148.98 implies an upside potential of 9.8%.

Summary.....

With an attractive valuation relative to peers, plenty of cash on the balance sheet, and explosive momentum happening across its biggest franchises, EA is a promising video game stock.

EA traded up $1.35 during trading on Wednesday, hitting $139.64. 95,832 shares of the company traded hands, compared to its average volume of 1,730,937.

The company has a market cap of $40.28 billion, a PE ratio of 20.49, a P/E/G ratio of 4.85 and a beta of 0.87. The stock’s 50-day simple moving average is $140.16 and its two-hundred day simple moving average is $120.68.

Arts Inc. has a 1 year low of $85.69 and a 1 year high of $147.36. The company has a current ratio of 2.61, a quick ratio of 2.61 and a debt-to-equity ratio of 0.05.


Option Trade – Farfetch Ltd (NYSE: FTCH) Calls

Tuesday, September 01, 2020

** OPTION TRADE: Buy FTCH JAN 15 2021 30.000 CALLS at approximately $4.00 (Up to $4.50).

Place a pre-determined sell at $8.00.

Also include a protective stop loss of $1.60.

Farfetch Ltd (NYSE: FTCH) is the leading digital sales platform for the fashion industry, and is growing at a rapid clip, and is eyeing up 2021 as the time it reaches positive adjusted EBITDA.

It's a valuable partner for department stores and luxury boutiques that may not have the means to set up a direct-to-consumer fulfillment operation. Farfetch believes that its relationships with luxury merchants cannot be easily duplicated and represent a key competitive advantage. 

The company delivered a record second quarter with digital platform gross merchandise value reaching an all-time high of $651 million, up 34% year over year. Revenue surged 74%, and its top 20 brands that sell direct to consumers over Farfetch's marketplace saw sales double year over year. 

In a press release, CEO and founder Jose Neves said, "I believe this ongoing acceleration behind our business results from a paradigm shift in luxury shopping, as the industry undergoes a major acceleration of the secular online adoption I envisioned in founding Farfetch." 

The acceleration it experienced during the rise of pandemic has continued into the third quarter. The demand surge puts Farfetch on pace to reach profitability based on an adjusted EBITDA  (earnings before interest, taxes, depreciation, and amortization) basis by 2021.

About Farfetch…..

Farfetch Ltd. engages in the retail of fashion and luxury goods. It offers womenswear, menswear, kidswear, vintage, fine watches, and fine jewelry. The company was founded by José Manuel Ferreira Neves in 2007 and launched in 2008 and is headquartered in London, the United Kingdom.

The Report.....

On Aug. 13, 2020, Farfetch released its second-quarter fiscal 2020 earnings report for the period ended in June 2020.

The Company reported a loss of (-$0.16) per share versus consensus analyst estimates for a loss of (-$0.24) per share, a $0.08 per share beat.

Revenues surged 74.6% year-over-year (YoY) to $365 million, beating consensus estimates of $326.92 million.

The Company saw over 500,000 new customers as a result of the pandemic.

Gross Merchandise Value (GMV) grew by 48% YoY composed of 86% third-party sellers at a 29.9% take rate. Digital Platform Services revenue grew 35% YoY. First-time buyers helped drive 60% YoY traffic growth on the platform, but average order value fell by (-18%) due to a higher mix of first-time buyers. First-party margins of In-house products produced by New Guards grew to 30% versus 10% YoY due to “better full-price mix” but top-line revenues also fell (-6%) YoY.

Farfetch's gross profit margins have consistently been at 40% or above for some time. During Q2 2020, its gross profit margins reach 43.7%, a meaningful improvement of 290 basis points from 40.8% in the same period a year ago.

Farfetch's improved profitability profile was predominantly driven by its Digital Platform which reported gross profit margins of 55% compared with 47.6% in the same period a year ago.

This gross profit improvement was driven by a combination of significantly reduced promotions and an increased mix of full-price items, as well as fewer discounting events and fewer free shipping campaigns.

Altogether, Farfetch's adjusted EBITDA dramatically improved from negative 21% in Q2 2019 to negative 8% in this quarter.

"These results show we are making excellent progress and driving growth on the platform, expanding unit economics and delivering operating cost leverage," CFO Elliot Jordan said during Farfetch's second-quarter earnings call. "Our goal of achieving adjusted EBITDA profitability across 2021 is another step closer."

The Pandemic Effect.....

Farfetch's growth story is far from over. As one of the largest online marketplaces for luxury goods, the company greatly benefited from the pandemic, as more people went online to purchase goods since luxury stores around the globe were closed in the first half of the year.

From April to June, Farfetch experienced record growth of GMVs and revenues and it was able to retain all of its top 100 third-party sellers on the platform. Considering this, there's every reason to believe that Farfetch will be able to keep its growth momentum, as there's already an indication that the company is on track to increase its top line in Q3.

“With the significant shift of consumer demand to online since the onset of COVID-19, brands and retailers’ focus on digital channels has intensified in Q2,” Neves said. “And we have expanded our partnerships to nearly 1,300 third-party sellers now participating on the Farfetch Marketplace, including more than 500 brands and over 750 retailers.”

Influencing Factors.....

One of the major advantages of Farfetch is its ability to retain its customers once they've purchased goods on the platform. Just recently, Farfetch's loyalty program ACCESS reached 2 million members, which account for 80% of the company's total active customers. At the same time, as a leader in a luxury goods market with no real competition, Farfetch will continue to attract new third-party sellers due to its vast market reach.

In addition, its recent deal with JD will help the marketplace to establish a stronger presence in China and benefit from the recovery of the Chinese luxury goods market, which already reached its pre-COVID-19 levels.

Another advantage of Farfetch is its ability to collect niche-specific data. By having millions of customers on its platform, the company can better analyze its users, find out what their preferences are, and better monetize them. This is probably the main reason why the company decided to enter the manufacturing side of the business and acquired the New Guard Group a year ago.

Despite numerous lawsuits that were filed against the company for its decision to purchase NGG, the acquisition made sense. With an ability to control the pricing of its NGG products, Farfetch could now easily leverage its platform and the data that it has collected to drive sales of its manufacturing business and become profitable over time.

Just recently, NGG's Off-While 'Sail' shoes generated 800 million hits for Farfetch's marketplace and were sold out on the day of their launch.

“In Q2, the number of baskets with both a New Guards item and an item from another brand doubled year-over-year,” Neves said. “And when the most recent Off-White Air Jordan collab Sail dropped last month, it sold out within the first hour and generated 800 million hits during that time with no marketing spend.”

In addition, Farfetch's brand division, which includes NGG, generated $66 million in revenues in Q2, while its gross margin was 41.8%. Considering such a good performance, it's safe to say that Farfetch's growth story is far from over and the company made a smart choice to purchase NGG last year.

Therefore bullishness is still apparent due to several factors.....

  • Farfetch is in one of the most pandemic-proof corners of retail. Not only is Farfetch benefiting from being primarily e-commerce, but Farfetch also focuses on high-end shoppers and labels.
  • Unsurprisingly, Farfetch's e-commerce platform has been the highlight of this year's results, but the company's diversification into owning retail stores (Browns in London) as well as its own brand collection (The New Guards Group, including labels like Off-White) distinguishes it from its competition that are purely e-commerce sites or purely brand labels.
  • Farfetch is based in London, but its markets are diverse and global, popular in the U.S. and China as well. In fact, strength in China, Europe, and the Middle East in Q2 helped to offset relative weakness in the U.S.
  • Farfetch has been dramatically boosting its margin profile and has a target to be adjusted EBITDA profitable by 2021. The company is also performing so well organically that it has also reduced its reliance on promotional spending, which is a crux that many retailers are using right now to survive.

Going Forward.....

Farfetch continues to be one of the biggest online luxury marketplaces in the world. The company has roughly 1,300 partners that sell products from over 3,000 luxury brands on its platform.

Farfetch's successful performance in recent months shows that its business is resistant to the pandemic and the economic crisis even though the luxury goods industry experiences its major decline in more than a decade. While some of its competitors had no other choice but to declare bankruptcy, Farfetch managed to thrive in the current environment, as it was able to retain all of its major third-party sellers in the last few months.

As more people now go online to purchase luxury goods, there's every reason to believe that Farfetch's growth story is far from over and its stock has all the chances to outperform S&P 500 in the following months, like it did in Q2.

Analysts Thoughts.....

Cowen analysts think Farfetch has set itself up for market share gains in the luxury space.

“We are encouraged by substantial growth at Farfetch versus other traditional luxury peers and believe Farfetch is gaining market share from both e-commerce and bricks-and-mortar competitors,” wrote analysts led by Oliver Chen.

“We view exclusive product offerings as vital for gaining market share in a highly competitive luxury market and driving higher full-price selling. Farfetch’s acquisition of New Guards Group allows Farfetch to offer consumers its original content, which should lead to both new customer acquisition and customer retention. Outside of New Guards Group, Farfetch has been building on its brand relationships to secure exclusivity for drop or capsule collections.”

Cowen rates Farfetch stock outperform and raised its price target to $33 from $26.

“We believe physical retail will shrink rapidly (Neiman bankruptcy and we think monobrand retailers) and we think that luxury brands will want a strong multibrand online environment,” wrote KeyBanc Capital Markets analysts led by Edward Yruma. “Over 500,000 new customers in 2Q should provide a strong foundation for post-COVID-19 growth.”

Moreover, long-term trends will be supported by the Farfetch Platform Solution (FPS), which helped the company’s marketplace partners grow their business during the pandemic, and retail technology initiatives that will help stores post-coronavirus.

KeyBanc rates Farfetch stock overweight and bumped its price target up to $32 from $25.

As the luxury category took a hit during the pandemic, JPMorgan analysts think Farfetch was able to stand out, in part because for some, it was the only game in town.

“We believe Farfetch became an increasingly important partner to boutiques, brands and other retail partners during the height of COVID-19 as many physical stores closed and even some online competitors were unable to ship from their distribution centers,” analysts said. “For many partners, Farfetch was the only way they could generate sales during the pandemic.”

With more inventory and help from FPS, Farfetch benefited.

“We think Farfetch is better positioned than any time since its IPO having made significant strides in direct brand e-concessions and adding selection from New Guards Group, while also showing greater cost discipline and commitment to Ebitda profit in 2021,” JPMorgan said.

JPMorgan rates Farfetch stock overweight and more than doubled its price target to $40 from $18.

Also, Farfetch had its price target upped by Deutsche Bank from $23.00 to $38.00. The brokerage currently has a buy rating on the stock.

Summary.....

The stock has soared 166% year to date, but it has only just recovered to the highs it reached shortly after its IPO. Farfetch has a massive opportunity to grow in the $100 billion online luxury market. Continued outperformance like what investors saw in the recent quarter should send shares even higher. 

Although Farfetch trades close to its all-time high, the company has way more upside. For Q3, Farfetch's expects to have $588 million to $609 million in GMV, which is higher in comparison to Q2. In addition, during the recent conference call, the company's management said that the business is on track to achieve adjusted EBITDA profit.

Farfetch has a debt-to-equity ratio of 0.22, a current ratio of 1.61 and a quick ratio of 1.39. Farfetch has a one year low of $5.99 and a one year high of $31.88. The stock has a market cap of $8.58 billion, a PE ratio of -26.12 and a beta of 3.09. The firm has a 50 day simple moving average of $22.74 and a two-hundred day simple moving average of $14.80.