Berenberg downgrades Keywords Studios to 'hold' as investments weigh on margins

Analysts at Berenberg lowered Keywords Studios from 'buy' to 'hold' on Thursday, noting that although its recent organic growth had been "exceptional" and the firm's mid-term organic outlook was "robust", the investment required to fulfil accelerating demand was depressing margins.

While Berenberg said the margin pressure should "only be temporary", with consensus pre-tax profit expectations requiring margins to improve "materially" in the second half, it felt the risk to near-term estimates had increased.

The German bank noted that Keywords delivered pre-tax profits of €18.4m, up 15% year-on-year, representing a margin of only 12% as a result of the group expanding its facilities during the period, as well as accelerating recruitment and training to meet its demand pipeline, which has accelerated faster than initially anticipated.

"While this additional investment stems from a positive catalyst – strong organic demand – and therefore bodes well for the medium-term outlook, it does raise concerns about whether Keywords can meet its margin guidance for FY 2019," said Berenberg, which also stated, "the room for error has narrowed".

Despite the increase in its revenue forecasts, Berenberg also highlighted that in order for Keywords to meet its full-year pre-tax profit estimates, margins would need to increase by 390bp to 15.9%.

"With the shares trading at 32x FY 2019 P/E, we feel the valuation is full and downgrade to 'hold'," said Berenberg. The analysts also raised their target price on the firm to 1,620p from 1,600p.