The Frontier Developments share price just crashed. Should I buy?

The Frontier Developments (LON: FDEV) share price has now lost 50% of its value in 2021. Roland Head explains what’s gone wrong and gives his verdict.

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The Frontier Developments (LSE: FDEV) share price crashed this morning, when the gaming company warned that sales of Jurassic World Evolution 2 have been “lower than expected” since its 9 November release.

Frontier stock has now lost 50% of its value since January. Given that I still think this is a good business, is the stock now cheap enough for me to buy?

What’s gone wrong?

Despite strong pre-order sales, PC sales of Jurassic World Evolution 2 have been less buoyant. Sales of Elite Dangerous: Odyssey are also said to have slowed this year.

Founder and CEO David Braben is hopeful that the sales shortfall will be made up over Christmas. But the new Jurassic World game is Frontier’s biggest release this year and will be its biggest revenue generator. Any disappointment could have a big impact on the group’s financial results.

To reflect this risk, management has cut sales guidance for the year ending 31 May 2022 to between £100m and £130m. To put this in context, analysts’ consensus forecasts before today were for sales of £140m.

Frontier admits this wide guidance range is a bit vague. The company says the uncertainty relates to the “variability of outcomes across our whole portfolio” ahead of the festive trading season.

I think this means that for some reason, there’s more uncertainty than usual about Christmas sales.

The end of the pandemic boom?

In addition to the Jurassic World Evolution series, Frontier Developments’ portfolio includes games such as Elite Dangerous, Planet Coaster and Rollercoaster Tycoon 3. As locked-down gamers spent more time playing last year, the company’s share price did well. Frontier shares rose by more than 150% in 2020.

However, the company’s growth didn’t keep pace with this rapid rise. Frontier’s revenue only rose by 19% to £90.7m in fiscal 2021, while the group’s operating profit climbed just 20%, to £19.9m.

Growth was expected to accelerate in the year to 31 May 2022. Broker forecasts before today suggested sales and operating profit would rise by more than 50% this year. Today’s sales warning suggests this is now unlikely, hence today’s crash.

In my view, Frontier’s share price got too far ahead of events last year, as investor rushed to buy lockdown stocks. However, market enthusiasm for gaming shares has cooled this year. Even before today’s warning, Frontier shares were down by 20%, as were those of rival Team17 Group.

Should I buy FDEV shares today?

In my view, there are two possible outcomes here. The first is that sales are being postponed and will rise sharply over Christmas.

The other possible outcome is that as the pandemic eases, gaming sales growth will also slow. Frontier’s big new release might not sell as many copies as expected.

I don’t know which outcome is most likely, but there’s an old stock market saying that profit warnings often come in threes.

I estimate that Frontier shares could still be trading on around 27 times earnings after today’s events. In my view, that’s not necessarily cheap enough to protect against further falls.

For this reason, I plan to wait for the company’s next trading update in January before deciding whether to buy. I’d rather miss out on short-term gains than suffer the pain of catching a falling knife. I think there are better buys elsewhere today.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Frontier Developments. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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