Declining Video-Game Hardware Demand To Offset Growth In Software Sales For GameStop In Q1 2015

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The U.S. video-game retailer, GameStop (NYSE:GME), is slated to release its first quarter (ended May 2) earnings report for the fiscal 2015 on May 28. [1] After a dull Q4 of the fiscal 2014, the company might witness a year-over-year (y-o-y) increase in the new video game software sales, owing to the improvement in title sales in the last 4 months. Furthermore, the company would be having high hopes from its mobile and consumer electronics segment, which showed promising growth potential in the fiscal 2014. In the fiscal 2014, the company managed to outperform 2013’s sales figures by roughly 2.8% to reach $9.3 billion, despite a dull Q4. Moreover, the 2014’s full year comparable store sales increased 3.4%, driven by growth in console sales and the pre-owned products category. In 2014, GameStop achieved its highest ever market share, with 28% share of next-generation hardware, 46% share of next-generation software, and roughly 42% market share of the downloadable content. Growth in the technology brands contributed significantly to the operating income and consequently, to the annual gross margins of 29.9%. [2]

Our price estimate for the company’s stock is $44, which is roughly 10% above the current market price.

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New Video-Game Software Sales Might Improve

According to the research group NPD, gamers spent $595 million on new physical software, hardware, and other accessories, up 3% year-over-year (y-o-y) in April 2015. However, the hardware sales were down 4% y-o-y to $184 million, due to a strong comparison with last year’s April sales, as well as a 55% decline in demand for previous generation consoles. In terms of unit sales, the demand for new generation consoles drove the growth by 12%. On the other hand, software sales witnessed 13% y-o-y growth to $256 million. [3] For the first trimester, hardware sales were down 10% y-o-y, whereas the software sales strengthened by roughly 5%.

Source: NPD data

This indicates that most of the core gamers, who have already bought new console platforms, are readily buying new titles to test them out on their new console systems. Despite the absence of major game titles, the software sales growth seems to have picked up lately. Electronic Arts’ (NASDAQ:EA) Battlefield Hardline and Warner Bros’ Mortal Kombat X were some of the new releases this quarter that kept the gamers interested in the physical title sales. We can expect a slight y-o-y growth in the software sales for the first quarter.

Double Trouble For Hardware Segment

On the other hand, the declining demand for previous generation consoles might negatively impact the hardware segment. The company witnessed a 30.2% y-o-y decline in the hardware sales in Q4 2014, primarily due to a tough comparison with the previous year’s figures. Q1 2014 also witnessed a major increase in the hardware sales, due to the demand for the then newly released next generation consoles. As a result, this year’s declining demand for previous generation consoles coupled with a tough y-o-y comparison, might result in disappointing hardware sales.

 

Expectations Increase From Technology Brands

GameStop has 484 technology brand stores, which generated around $329 million in revenues for the company in the fiscal 2014, with operating margins of 10%.  The 484 Technology brands include 361 Spring Mobile stores, 63 Cricket Wireless stores, and 60 Simply Mac stores. In February 2015, GameStop showed interest in some of the store locations of RadioShack, which declared bankruptcy earlier this year. RadioShack got the approval from a U.S. Bankruptcy Court Judge to auction its 2,000 stores. [4]  GameStop, however, won the auction for the right to take over nearly 163 RadioShack stores, with a payment of $15,000 per store to take over the leases. [5] GameStop expects a potential IRR of 25% from these stores. The company expects the segment to contribute over $1.4 billion in sales and $170 million in operating profits by 2019. It might become one of the most profitable segments for the company in the coming few years.

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Notes:
  1. GameStop, Q1 2015 earnings call conference []
  2. GameStop Q4 2014, earnings call transcript []
  3. April 2015 NPD games data []
  4. RadioShack goes to auction to test hedge fund $200 mln deal []
  5. GameStop wins bidding for more than 160 RadioShack stores []