Has DraftKings’ stock price bottomed out or will it continue to decline? (NASDAQ:DKNG)

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I am assigning a sell investment rating to DraftKings Inc. (NASDAQ: DKNG) shares. I see DKNG shares continuing to fall as it will take some time (i.e. a few years) for the company to reach positive free cash flow and earnings and loss-making names are no longer favored by investors currently.

Why has the price of DraftKings dropped?

DKNG bills itself as “the only vertically integrated US-based sports betting operator” and “a multi-channel provider of sports betting and gaming technology” in the company’s press releases.

DraftKings 2022 Year-to-Date Stock Price Chart

DraftKings 2022 Year-to-Date Stock Price Chart

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DraftKings stock price fell -60.3% in the first six and a half months of this year, while the S&P 500 fared relatively better with a -21.3% correction.

In my view, there are two key factors so far that have driven DKNG’s shares sharply down in 2022.

The first key factor is a clear shift in investor preferences, with DKNG no longer in favor.

On January 25, 2022, Tech Crunch the commentary pointed out that “profitability” was more correlated with “positive stock market returns in the software sector” in 2021 compared to “revenue growth” for the first time in five years. In 2022, it is clear from the stock performance of DKNG and other similar fast-growing but unprofitable companies that the market clearly favors profitable stocks over their loss-making counterparts across all sectors.

JPMorgan (JPM) Asset Management also published a recent article on May 25, 2022 which highlighted that “value has outperformed growth by a significant margin so far in 2022” and noted that “value should benefit from tailwinds to term” due to a reversal of past underperformance, inflation and under-allocation by institutional investors. DraftKings is obviously in the growth stock category given its high revenue expansion rates (2017-2021 revenue CAGR of +61%) and lack of profitability (still loss-making at EBITDA currently).

The second key factor relates to DKNG’s ability to finance its future growth.

A Looking for new Alphas The article published on May 31, 2022 noted that “it is unclear whether new market entries in California and other locations could drive the company to raise funds through a capital offering. ‘shares’. According to sell-side consensus financial forecasts obtained from S&P Capital IQDraftKings is expected to generate negative free cash flow of -$929 million in fiscal 2022, compared to negative free cash flow of -$435 million generated in fiscal 2021.

At the Goldman Sachs (GS) 2022 Travel & Leisure Conference on June 6, 2022, DraftKings assured investors that it has a “multi-year plan that doesn’t require us to raise more capital” and that it has “tested this plan under a variety of scenarios.” As of March 31, 2022, DKNG had approximately $1,773 million in cash on the company’s books according to S&P Capital IQ, which should allow the company to maintain business operations through the end of 2023 at worst.

Nevertheless, DKNG mentioned at the recent Goldman Sachs conference that “there could still be a black swan type situation like what happened when the sport closed in 2020” which could affect future expectations for capital and cash flow of the company. In the current market environment, it’s no surprise that investors are fearful and tend to price in worst-case scenarios for most stocks.

In the following section, I review the financial performance of DraftKings in the first quarter of 2022.

DKNG Stock Key Indicators

DKNG announced the company’s financial results for the first quarter of 2022 on May 6, 2022, before trading hours.

DraftKings Post-Q1 Earnings Announcement Stock Price Performance

DraftKings Results After Q1 Stock Price Performance

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According to the chart above, the initial market reaction to DKNG’s Q1 2022 results was unfavorable. While DraftKings’ stock price performance then rallied a week later, it simply matched the performance of the S&P 500. Overall, in the month or so since the earnings announcement of the Q1, DKNG shares were down another -9.3% and underperformed the broader market.

DKNG’s revenue grew +34% year-on-year, from $312 million in Q1 2021 to $417 million in Q1 2022, +1.4% above Wall Street expectations. Looking ahead, DraftKings has revised the company’s forecast for fiscal 2022 revenue from $1,850-2,000 million to $2,000-2,025 million, as part of the earnings release. results for the first quarter of 2022.

But as I mentioned in the previous section of the current article, the market is now more concerned with profitability than revenue growth. As such, it was disheartening to see DKNG’s non-GAAP adjusted gross margin contract drop from 50% in Q1 2021 and 53% in Q4 2021 to 32% in Q1 2022.

During the company’s first quarter 2022 earnings call, DraftKings explained that its first quarter 2022 gross profit margin “was significantly impacted by the New York launch, which recorded a negative gross margin during the quarter. because the first quarter was its launch quarter”. These types of investor fears have confirmed that DKNG’s aggressive expansion into new markets will hurt its future profitability and free cash flow generation. As such, it’s understandable that DKNG’s share price has remained weak despite above-expected Q1 2022 revenue.

Is DKNG undervalued?

DKNG may appear undervalued based on Wall Street analysts’ price targets, but my analysis suggests otherwise.

The average sell-side target price for DraftKings is $28.13, which is +155% upside from its last stock price of $11.03 on June 13, 2022. Most Bearish Analyst covering stock DKNG thinks its stock is worth $13.00, which equates to +18% capital appreciation potential. Since individual analysts would have used different valuation methodologies and assumptions to arrive at their respective price targets for DKNG, it is difficult to judge the relevance of their valuations.

By my calculations, DraftKings’ latest stock price of $11.03 translates to a rather rich forward P/E multiple of 30 times applied to the company’s consensus earnings per share for fiscal year 2026 of $0.66 (depending on S&P Capital IQ) discounted to the present using a discount rate of 14%.

My own valuation analysis suggests that DKNG is overvalued, or at best fairly fairly valued, based on the implied FY2026 C/E multiple based on its current share price.

Has DraftKings bottomed or will it continue to drop?

I think the DraftKings stock price will continue to decline. Indeed, the factors that have led DKNG shares to fall since the start of 2022 could still put downward pressure on the stock in the near future.

Given the worse than expected inflation figures for May 2022, the market should maintain its preference for value stocks that are profitable. This suggests that it won’t be any time soon for investors to return to growth stocks such as DraftKings.

DKNG’s road to profitability and generating positive free cash flow is still a long way off. Consensus financial estimates from S&P Capital IQ indicate that DKNG made its free cash flow positive and profitable (income) in the financial years 2025 and 2026, respectively. As previously reported, the company’s gross margin contraction for the first quarter of 2022 suggests that continued market expansion will dampen its profit margins and free cash flow generation, increasing the risk of an increase. capital in the future.

As such, I believe the negative momentum in DKNG stock price will continue for the time being.

Is DKNG stock a buy, sell or hold?

DKNG stock is a sell. The company’s shares haven’t bottomed out, as I think its current valuations are unattractive. Based on my analysis, the market is currently valuing DraftKings at a rather high FY2026 P/E multiple of 30x.

Karen J. Nelson