Stunning Revenues Power DraftKings Higher

What a year it’s been for DraftKings (NASDAQ:DKNG) stock, up 162.2% year-to-date after plunging from highs above $70 in 2021 to almost single digits earlier this year.

The good news continued after a better than expected Q3 report, which follows a series of impressive top line numbers. Revenue growth has been accelerating in previous quarters, from $501.9 million in Q2 2022 to $874 million in Q2 2023.

That’s the kind of spectacular pace Wall Street gets excited about, and it’s rewarded shareholders handsomely this year as a result. Now the question is whether it will continue?

One overarching reasons bears have remained skeptical of DraftKings is the sustained quarterly operating income losses. Over the past 12 quarters, a string of EBIT losses was unbroken, and ranged from just under $100 million to close to $500 million per quarter.

With losses accumulating, it’s no wonder balance sheet cash has declined so precipitously from $2.8 billion at the start of 2021 to $1.1 billion last quarter.

Another concern has been the sequential periods of negative levered free cash flows. Over the past three years, all but two quarters had negative levered FCF.

So what does it all boil down to, is DraftKings a bargain in spite of the share price appreciation this year?

Is DraftKings Stock Undervalued?

DraftKings is 29.4% undervalued according to the consensus estimate of 31 analysts who have a $35.79 per share price target.

The caveat to the bullish forecast is that a discounted cash flow analysis places intrinsic value closer to present levels at $31 per share, representing less than 10% upside.

What shareholders can cling onto is a top line revenue growth that is nothing short of scintillating. In just twelve quarters, sales are up from $132.8 million to $874 million.

Marketing continues to be the largest expense. Management clearly has a business model thesis that the enormous marketing spend to build a brand will pay off with customers returning again and again, thereby boosting customer lifetime value (CLV) over the long-term.

Pros and Cons of Investing in DraftKings

So the top line has been the most impressive aspect of DraftKings profit and loss statement, and further, analysts expect sales growth to continue this year but there are some blots on the copybook, so to speak.

For one, DraftKings operates with a pretty dismal return on assets of -30.1% and has not been profitable over the past twelve months. So too is it trading at relatively high multiple to sales, a figure last reported at 4.5x LTM sales.

The primary reason to buy DraftKings has to be a belief that its vast marketing spend will one day turn the company into a money generator because the current ratios are all pretty abysmal. For example, net income to common margin is -38.9%, return on common equity is -83%, and return on invested capital is -36.2%.

Management absolutely must turn the profitability corner on a sustained basis in order to persuade conservative institutional investors, who have the deep pockets to drive prices higher, that the spike this year is the start of a multi-year move.

The decline in cash over the past few years cannot be ignored, not least because its pace has been so rapid. With that said, the company’s long-term debt hasn’t grown appreciably over the same period, so it appears operating costs simply need to be checked to slow the cash burn.

Is DraftKings Stock a Buy?

In its most recent quarter, Q3 2023, DraftKings continued its impressive streak of top line growth reports, announcing a 57% climb in revenues from the year ago quarter.

Adding to the tailwinds was a hike in 2023 revenue guidance to a midpoint of $3.6 billion and a forecast that 2024 figures would range from a low of $4.5 billion to a high of $4.8 billion.

Where investors need to focus most is the recurring nature of customer payments. Are they coming back and spending more? If so, it would validate management’s thesis to spend heavily on marketing now and reap the rewards of brand loyalty later.

It seems that all the signs are pointing favorably in that regard with Monthly Unique Payers up to 40% from a year prior to 2.3 million.

Those metrics in conjunction with a favorable valuation signify that DraftKings remains a Buy at this time and should continue to grow strongly in the online sports betting and iGaming industries.

Wrap-Up

The ideal business model is one with positive unit economics from the get-go, meaning that a company can squeeze out a profit on each unit of product or service sold and scale as much as possible.

Another approach is to delve into the well of capital on the balance sheet, spend heavily on marketing to establish a brand, and hope to earn a payback down the line. Companies like Uber would fall into this category, whereby they spend heavily in each city they establish a presence in order to build awareness, and then hope customers will continue to return again and again. 

The upfront spending generates losses short-term but is really an investment in long-term returns that boost customer lifetime values. DraftKings falls into this second category. It is aiming to build the premier brand in the online sports betting world, and making its own bet that customers will then default to its platform for parlays and other flutters for years to come.

So far, those investments in marketing have been paying off handsomely with revenues soaring year-over-year during the past three years. Equally the losses have been accumulating and hurting the company’s cash pile. But management appears to be turning the corner to profitability, and with a bottom line in the black, expect DraftKings to build a brand moat that could last long into the future.

The most recent report was perhaps just a breadcrumb on the road that points to where the stock is going to go long-term, perhaps even back to its old highs.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.