Stockwatch: the growth outlook for this turnaround story

Image: Eugene Mymrin via Getty.

A circa 20% rise in shares of the video games publisher Frontier Developments (LSE:FDEV) in response to annual results to 31 May, can seem aggressive given that the numbers were essentially “in-line” and there was no specific upgrade for the May 2027 year. I note that with quite a lot of shares currently, where updates are triggering share price spikes, as if sentiment generally is upbeat and looking for any chance to explore upside.

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Given that September and October are  supposedly riskier months for equities, that can seem a bit odd, especially now that oil is flirting with $100 a barrel as the US/Iran conflict continues, and now that gas prices are looking exposed on the upside for winter. In May, supposed experts were saying that a failure to resolve energy passage in the Strait of Hormuz would trigger $150 oil anytime soon, hence a recession. While that now seems like an overstatement, is partying in riskier shares a sign of complacency?

Without engaging confirmation bias – having tipped this share last May at 400p, currently 535p – I think the odds still lie in favour of Frontier continuing to define a useful turnaround, with sales growing into 2027 and 2028. 

Its current share price essentially recovers the level 10 months ago, and for what chart theory is worth, the five-year context looks to be evolving a bullish “bowl”:

Source: TradingView. Past performance is not a guide to future performance.

One difficulty is figuring what might be the price/earnings (PE) ratio. Published consensus data shows the apparently curious scenario – after very strong profit and cash flow numbers – pencilling in around £15 million net profit in the current financial year, down from £27.3 million, then a further decline to near £12 million to May 2028. This implies a reduction in earnings per share (EPS) from 70p to 34p on a 16x multiple.

Some of this could reflect higher research and development spending, a bugbear for investing in this type of company – you either stomach it or steer clear.  The hope is that it generates a blockbuster or two, but when involving a relatively small company like Frontier, it sets up potentially high earnings variability.

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Given the forecasts – for a company of this size – will likely derive from its own broker and possibly sponsored (paid-for) research, they would have included input from the finance director. I would not therefore treat expectations for earnings decline casually but think that consensus for revenue also to fall (modestly) from £105 million to £102 million this year, and £97.0 million in 2028, is very conservative – especially given the latest operations statement. 

More likely this reflects management wanting published expectations to be modest so that any kind of warning can be averted, given that the timing of games releases can be significant to reporting periods.

Very strong May 2026 across the board

Annual revenue has grown 16% to £104.8 million, hence a quintupling over 11 years (see table) albeit still below £114 million in the May 2022 year. However, that period benefited from lockdown spending, hence was exceptional. 

Revenue growth is from a low base but the nature of video games – if originated and executed well – offers growth-type dynamics. A total of 89% of revenue now relates to the creative management simulation (CMS) genre of games which enable players to evolve their own content, such as Planet Coaster, Planet Zoo, and the Jurassic World Evolution series - especially last October’s launch of the third iteration of this game.

Adjusted operating profit up 62% to £21.4 million is at first sight even more impressive, helped by “disciplined cost control and higher tax and expenditure credits”. The income statement shows “other operating income” up from £3.9 million to £11.3 million, note 3 clarifying as involving a £9.3 million Video Games Expenditure Credit (call it a subsidy if you like). But adjusting for this still gives an impressive profit dynamic, while reported operating profit virtually doubled to £25.0 million. Excluding a £3.9 million publishing rights gain in the prior year, normalised operating profit more than doubled.

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Cash generation was a record £19.0 million before £17.5 million was spent on buybacks and employee benefit trust purchases, leaving £44.0 million cash at the 31 May financial year-end and £51.4 million at end-August. The table shows how free cash flow per share has soared from 3.2p in 2024 to a record 51.0p in respect of May 2026.

At 535p, Frontier’s trailing multiple of diluted EPS is thus 7.7x and on free cash flow per share, 10.6x. You could say that leaves scope for both multiples to rise (as underlying measures fall) over the next two years, amid games development spend.

Frontier Developments - financial summary
year end 31 May

Source: historic company REFS and company accounts.

One reason I remain a bit puzzled by the consensus for profits decline is that the cash flow statement is already showing an 11% reduction in spending on games development (to £27.0 million “expenditure on other intangible assets”). It would have helped to explain in the operations and financial review if this must now materially rise – even if for potentially value-generating reasons – than have guided down expectations (if that was the case).

Despite such propensity for expenditure meaning no ordinary dividend policy, there is to be a £5 million special dividend payable on 9 October, equating to a dividend per share of 14.1p, or a yield of 2.6% at the 535p market price.

‘A strong road map of new content’

The content road map potentially explains the development expenditure but also scope to beat what may be very conservative guidance.

Planet Zoo 2 launches on 13 October and Warhammer 40,000: Chaos Gate – Deathwatch (I will let you figure) is scheduled for release before the end of next May.  

For the May 2028 year, a new own-IP CMS game to extend the Planet franchise is targeted, then an average release cadence of one new CMS game per year for the 2029 year and thereafter. That’s fine if these do well but obviously it is a narrow field, hence has scope for financial variance.

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More positively, a 3 September announcement about collaboration with Disney to develop and publish a new CMS game (timescale not indicated) implies the scope is widening given Disney’s extent of intellectual property.

Furthermore, and if games are successful, it could raise Frontier’s appeal for an acquirer to substantiate and possibly smooth its own earnings profile. But I wouldn’t add too much weight to takeover speculation as this is significantly a “people business” where teams are mobile whatever contracts say.  

I should be careful not to let speculation tempt me into assuming a bull market when management says its 2027 year is “expected in line with market expectations under the next phase of franchise-led growth” but which includes two years of profit decline.

Tempering my recent ‘buy’ case in May

The appropriate stance at 540p looks like adjusting to “hold”, but I think it’s a firm one given the way Frontier is shaping up in a publishing sense.  

You could say January’s departure of Jonny Watts – who served as CEO from August 2022, hence was responsible for the turnaround and also provided key creative input having founded Frontier in 1998 – is cause for concern. But the chief marketing officer stepping into the CEO role is an ideal substitute and they are already delivering.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.