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Why NetEnt looks like a good buy right now

TAGs: netent

While no gaming market looks especially safe to invest in an absolute sense right now, the Swedish market looks to have one of the more favorable risk profiles. Here we’ll take a look at NetEnt to make that case.

Why NetEnt Looks Like A Good Buy Right NowNothing particularly exciting is going on with NetEnt at the moment, and its stock price has reflected that over the last two years. Shares have fallen 60% since mid 2016, clinching levels not seen since 2014. Both revenues and earnings have more than doubled since then, so there’s a long term disconnect here. Dividends have also climbed 170% per share. The simple conclusion is that either NetEnt was overvalued then, or it’s undervalued now, but probably some combination of the two.

Back in 2014, NetEnt was a rip-roaring explosive growth company. Now it’s not anymore, for now at least, but that doesn’t mean a 60% fall in shares was warranted. NetEnt isn’t declining overall. It is still comfortably profitable, it has no debt and an overall very healthy balance sheet. It’s just that its major markets look to have matured and it needs a new way forward. This is just the next step in company development it has to confront.

The transition from momentum stock to stable income stock, which NetEnt looks to have crossed, means that speculators stop chasing it higher, and a decline ensues. Exacerbating the decline in this case may be the new Swedish gaming regulatory regime, which is adding an 18% gaming tax in 2019 that NetEnt has warned will affect revenues negatively.

There’s a silver lining though to moving from momentum stock to income stock. The investment becomes a safer, more stable defensive investment. When times turn more turbulent and hedge funds need to play defense, these stocks may not necessarily climb during the turmoil, but they don’t lose as much either compared to picks that just recently hit their all time highs. It would be one thing if NetEnt were in a real decline and had to make major changes to restabilize. In that case nobody really knows where the bottom is. But this is not the case here. Given NetEnt’s stable business, nonexistent debt, and the fact that the stock has lost 60% since peaking, it could end up becoming a popular defensive choice when the business cycle turns.

A big deal was made about NetEnt’s disappointing numbers in the UK, but gamewin percentage hasn’t declined there. It’s only stagnated, which isn’t so bad considering the fear factor of further UK investment only 7 months away from a possible hard Brexit. Overall, revenue growth has exceeded cost growth for 4 out of the last 5 quarters, so fundamentally NetEnt is in good shape. It’s just not as exciting as it used to be.

With the stock at these levels, there isn’t all that much to lose. NetEnt has been paying dividends since 2005 and has never cut them. At current prices the yield is 6.2%, a very good deal if they can be maintained. They probably won’t be growing any time soon because the payout ratio is 98%, but the good news is that’s down from 107% last year. So NetEnt is back to keeping some of its earnings rather than paying it all out to shareholders. It look more like a Master Limited Partnership or trust now than an independent single gaming company considering how much it pays shareholders. If NetEnt could make a 107% payout without cutting dividends and bring that number down below 100% despite disappointing growth, then it seems keeping dividends stable is a company priority. On that note, free cash flow has doubled since September 2017, so the high dividend doesn’t seem to be in any imminent danger.

Long term NetEnt could be a great pick right now. The Eurozone is going to get pretty dicey as we head into the end of the year, with the European Central Bank set to end its bond-buying by then. Brexit will follow in March regardless of any deal being struck or not. Best case scenario, the ECB extends its bond-buying program, and a Brexit deal gets agreed on. Rumors of the ECB extending quantitative easing, perhaps a public trial balloon to see how markets respond to the possibility, are already hitting mainstream financial media. Stocks across Europe will have a huge relief rally if either the ECB comes through or a hard Brexit is avoided. Both are possible.

Worst case scenario, the ECB really does end its QE program come December, Italy comes under a speculative bond attack, and the UK leaves the EU without a deal. Stocks across the world would plummet in that case and Europe would be ground zero. Leveraged companies with lots of European revenues would be hit badly. NetEnt would struggle like the rest, but struggles won’t reach desperate levels. It would comfortably get through, though not completely unscathed, because of its healthy finances now.  If the stock falls it won’t fall nearly as far as leveraged competitors in the UK, and NetEnt may be in a position to acquire assets on the cheap at that point as competitors scramble to raise liquidity in order to pay off debt.

Taking a position in NetEnt now is a bet that nothing will get markedly worse, and that the company will at least maintain its dividend for the long term. The chances of that look not certain, but fairly decent. If shares can stay more or less stable through the upcoming dangerous period between December and March of next year, NetEnt will have succeeded, at least insofar as its shareholders are concerned.

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