Sustained Demand For Next-Generation Consoles To Drive GameStop’s Q2 Results [Part 1]

GameStop (NYSE:GME) is scheduled to report its earnings for the second quarter of fiscal 2014 on Thursday, August 21.  ^[1] The video game retailer giant witnessed a 7% increase in net global sales in the first quarter, of which 3% was due to technology brands. Consolidated comparable sales rose 5.8%, primarily driven by continued strong consumer demand for next-generation consoles and excellent performances by the pre-owned products segment and technology brands. The company’s new hardware sales grew 81% as compared to a 20% decline in new software sales in the first quarter. ^[2]

According to the research group NPD, demand for next generation twin console- the Microsoft (NASDAQ:MSFT) Xbox One and the Sony PlayStation 4- is still strong, which might benefit video game retailers such as GameStop (NYSE:GME). In the latest July NPD report, U.S. gamers spent $514.3 million on new physical video game sales including hardware, software and other accessories, up 16% over the last year’s figure. ^[3]

In this article, we will discuss the impact of strong console demand on the top-line growth of company’s core profitable businesses: Pre-Owned Products & Value segment, that basically works on the buy-sell-trade strategy of GameStop, and the Video Game Hardware & Software segment. These segments combined, account for nearly 70% of the company’s total value according to our estimates. In a later following article, we will take a look at the new areas of focus for the company- Digital Sales Segment and Technology Brands, in which the company is yet to make a strong impact. The performance of these two segments represents the company’s stand in the industry.

Our price estimate for the company’s stock is $47, implying a premium of 17.5% to the current market price.

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For the second quarter, GameStop expects comparable store sales to improve by 12%-19% and diluted EPS to be in the range of $0.12 to $0.20. The company might be anticipating excellent sales growth in the new video game hardware segment, which might translate to an improved performance by the pre-owned products segment as well.

Sustained Strong Momentum In Console Sales

According to the NPD report, console sales were $198.8 million in the month of July, up nearly 100% from $99.8 million. Last week at the Gamescom 2014, Sony Computer Entertainment Europe’s CEO Jim Ryan revealed that the company has sold 10 million units of its PS4 consoles, indicating the strong momentum of its next generation consoles with still 3 months to go for its one-year mark. ^[4] On the other hand, Microsoft is yet to reveal its Xbox One console sales. However, in early January, the company revealed that it sold 3 million units of its Xbox One consoles. Moreover, the net Xbox console units sold in the last 6 months sums up to 3.1 million, as mentioned on the company’s website. ^[5] Considering that the Xbox One accounted for almost 95% of these Xbox sales, we estimate the net Xbox One sales till date to be approximately 6 million. In short, the total next-generation console units comes out to be 16 million and their combined sales is up 80% from the last cycle of consoles, indicating a strong demand for hardware. The increasing demand for consoles might be reflected in GameStop’s Q2 results and it might translate into increased software sales and improved pre-owned product segment’s performance in the coming quarters as well.

• Increased New Video Game Hardware Sales

New video game hardware sales rose 27% in 2013, contributing around 19% to the company’s overall revenue growth. ^[6] Moreover, in the first fiscal quarter of 2014, company’s hardware sales increased 81%, stronger than the U.S. market’s average of 61% growth. After a positive monthly July NPD report in terms of hardware sales, GameStop is optimistic of its top-line perfrmance for the hardware segment and expects the sales to be on the higher side of the guidance for the rest of the year.

Since this a low margin segment (gross profit margins were 10.2% for this segment in 2013), this might possibly have no major impact on company’s valuation, but it might indirectly boost sales for other segments.

• Lagging Software Sales Might Get Boosted

According to the July NPD report, gamers spent only $178.2 million on new software, down 15% year-over-year. This might be due to reduced title releases in the quarter and as some of the last-generation titles are not compatible with new generation consoles, the gamers might have been left in a handicapped position.  However, the popularity of the new consoles portends a software revival is just around the corner. With the launch of new game titles in the back half of this year, the software sales are expected to catch up.  Top game developers such as Electronic Arts (NASDAQ:EA) and Activision Blizzard (NASDAQ:ATVI) unveiled their most awaited games of the year at the 2014 Electronic Entertainment Expo (E3), revealing trailers and prototypes of newer editions of their famous title franchises. With a turnout of around 49,000, E3 also witnessed other video game developers such as Microsoft (NASDAQ:MSFT), Sony Corporation, Ubisoft and Nintendo disclosing concept visuals and early designs of their title releases. When these titles will come out in the market, the gamers with new console systems will rush to buy the popular titles to try it on their new system.

Trefis estimates an annual growth of around 8% in the new video game software revenue per square foot in 2014, most of which would be seen in the latter half of the calendar year as the company usually earns 40% of its revenue in the fourth quarter.

New software sales accounted for 39% of the overall company sales and 30% of the total gross profits in 2013. As it is a high margin segment for the company, its revival might significantly boost the overall performance of the company.

We have discussed the impact of the strong console sales on these segments briefly in our prior article. (See: Strong Console Sales To Drive Revenues For GameStop & Electronic Arts )

• Pre-owned & Value Product Segment: Margins Might Improve

The company’s integrated buy-sell-trade model has been a vital segment in the company’s core physical game business for the past few years. Pre-owned product sales during the first quarter grew 5.3% year-over-year, with a 7% growth in the U.S. Around 30% of the next generation hardware and software was purchased with the help of trade credits, indicating consumers’ interest in the model and providing inventory for growth of this segment in 2014. The highlight of Q1 was the improvement in margins of the pre-owned and value product segment to 49.5% due to improvement in console sales. ^[7] The popularity of new consoles are expected to stimulate a new cycle of trade-ins just as it did for the prior year, positively affecting the pre-owned business.

Moreover, GameStop is continuously expanding its pre-owned business by adding lower-priced products to the division, including software with price points below $20. This sub $20 category resulted in $400 million in sales last year, but GameStop does not have the same dominance that it enjoys in the regular price category.

Furthermore, trading of used video game products is expected to grow with the anticipated rise in pace of software sales. GameStop’s used game sales are highly correlated with new game sales, as the latter help replenish the company’s inventory; pre-owned game sales have consistently been around 65% of new software sales for the last four years. We estimate the revenue from this segment to have a double digit growth of around 15% over the prior year and to account for nearly 43% of the company’s gross profit in the fiscal 2014. Since this segment has the highest gross margins among all other segments, its performance will remain the key focus for the company.

Overall, the company is poised for a strong performance in its core segments in Q2 and in upcoming months as well.

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1. Q2 2014 GameStop Corp. Earnings conference call [↩]
2. GameStop Q1 earnings call transcript, May 2014 [↩]
3. July NPD Report [↩]
4. Sony’s PlayStation 4 has sols 10M units worldwide [↩]
5. www.microsoft.com, Key Performance Indicators [↩]
6. GameStop’s Q4 2013: Earnings call transcript [↩]
7. Ref: 2 [↩]