GameStop Revised to $26.75 after Q2 2012 Earnings

Video gaming retailer GameStop (NYSE:GME) released its Q2 fiscal 12 results on August 16. ^[1] While the results were disappointing with declines of 11% in net sales and 9.3% in comparable sales compared to Q2 2011, strong cash flow during the quarter and a 67% increase in its dividend has caused the stock to gain nearly 15% after the earnings disclosure. Below we highlight the major trends during the quarter. GameStop is a leading retailer of new and used video-gaming products competing with the likes of  Wal-Mart(NYSE:WMT), Best Buy (NYSE:BBY) and Amazon (NASDAQ:AMZN)

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Retail sales remain challenging

In-line with the trends across the global video gaming industry, retail sales at GameStop remained challenging throughout the quarter. In terms of business segments, GameStop’s new video game software sales declined by 21%, primarily due to the lack of major titles during the quarter, and the shift of gamers from traditional console based retail games to digital games. We expect the sales to improve over the next quarter, with major titles such as Madden NFL 13, FIFA Soccer 13, Skylanders Giants and Resident Evil 6 scheduled for launch in Q3.

Additionally, GameStop’s new video game hardware sales declined by a massive 33% during the quarter. GameStop cited the end of the seventh generation console cycles as the major factor behind the decline, and expects sales to improve after the launch of Nintendo Wii U, which is expected to be launched in Q4 2012. However, we believe new console sales trends will continue to remain a challenge for the company, as eighth generation consoles will face stiff competition from alternate gaming devices such as smartphones, tablets, and Smart TVs.

Analyzing GameStop’s digital sales and what to expect ahead

GameStop’s Q2 digital revenues grew by a modest 27% compared to nearly 50-60% growth throughout 2011. The primary reason behind this decline in digital revenue’s growth was a slump in GameStop’s console digital revenues, which grew by a meager 9%  this quarter.  As third-party downloadable content (DLC) contributes a lion’s share to GameStop’s console digital revenues, entry of third party developers into digital distribution such as Activision’s Call of Duty: Elite service has significantly hurt the company’s console digital revenues. See: GameStop’s Growth Challenged by Rising Digital Downloads

On the other hand, GameStop’s PC digital revenues continues to grow strongly, increasing by 76% this quarter. We believe that the major part of this growth was due to the launch of Diablo III during the quarter, which is a PC exclusive game. Going forward, we expect the growth in PC digital revenues to  continue, gaining from the launch of World of Warcraft: Mists of Pandaria and higher digital game downloads through its PC download platform Impulse.

We have a revised price estimate of $26.75 for GameStop stock, which is roughly 40% above the current market price. Along with a change in GameStop’s current net cash/debt position, the adjustments in our price estimates primarily reflect a decline in GameStop’s near-term revenue outlook, and adjustments to the 2012 and 2013 capital expenditures.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. GameStop reports Q2 fiscal 12 results, Source: GameStop’s IR [↩]