Can It Be A Comeback Season For GameStop?

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The summer season has brought relief to the U.S. gaming industry, despite the absence of major game releases. According to the NPD report, monthly software sales are up year-over-year (y-o-y) for a major part of this year, whereas monthly hardware sales have picked up pace in the last two months. [1] The sustained demand for the next-generation consoles and an impressive line-up for the remainder of the year will be the driving force for the U.S. video game retailer, GameStop (NYSE:GME). The company is scheduled to report its second quarter earnings results for the fiscal 2015 on August 27. [2]

GameStop’s stock has risen more than 15% over the last 3 months, and the market is expecting the company to report an EPS figure of 24 cents in the second quarter. [3] With signs of improvement in terms of software sales in the industry, and the robust growth of the Technology Brands and digital segment, GameStop might come out of the dark phase it has been witnessing for the past couple of years.

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Our price estimate for the company’s stock is $41, which is roughly 10% below the current market price.

See our complete analysis of GameStop

Software Sales Growth Is Not As Bad As It Seems

Last year, the gaming industry struggled in terms of software sales, and it was estimated that it might worsen this year. However, the situation is far better than the expectations. The NPD software sales data clearly indicates that the gamers have spent 2% more on software in the first 7 months this year, compared to the same period last year. [4] Moreover, the fact to keep in mind is that there has been no major releases in the first half of 2015, compared to some of the blockbuster releases last year, indicating the major shift in title sales trend this year. Probably, most of the gamers who have brought new console systems last year are now buying game titles to try them on those platforms.

On the other hand, some of the core titles released last year, such as Electronic Arts’ (NASDAQ:EA) sports titles, namely FIFA 15 and Madden NFL 15, and Activision Blizzard’s (NASDAQ: ATVI) Call of Duty Advanced Warfare and Destiny, are still in strong demand among the respective game lovers. Most of these titles are still among the top 10 games being sold per month in the U.S.  The trend indicates that these games will continue to rule the software charts, till the release of their next versions later this year. In the 2015 Electronic Entertainment Expo (E3) held in June 2015, we witnessed that the top game developers in the industry have impressive line-ups to be launched in the coming few months, further boosting the company’s potential growth in the software segment for 2015 and early 2016.

Reversal In Trend?

Now, the question that arises automatically is whether this year’s line-up for the holiday season is strong enough to outperform last year’s impressive growth. Should that happen, we might see a reversal in last year’s trend, where software sales were lagging. Furthermore, the current trend in hardware sales seems to support the point. Combined hardware sales in the first 7 months declined 7% y-o-y, primarily due to the declining demand for last generation consoles (PS3, Xbox 360). [5] PS4 sales for the first 7 months remained flat y-o-y, matching up to the strong sales last year in the same period. On the other hand, Xbox One sales increased 20% y-o-y over the same period, as the console prices dropped $150. [6] This indicates that gamers have moved on from the last generation consoles and are buying the new console systems. With no more options to upgrade, gamers will eventually shift to software purchases. Generally, when a new console system is released, the focus of users shift more to hardware purchases, and after most of the transition to new systems is complete, users shift back to software title purchases. So to put it more aptly, the real question is whether this transition will happen this holiday season.

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Trefis estimates the new video game hardware revenue per square foot for GameStop to decline to $231 by the year 2016, whereas the new video game software revenue per square foot is estimated to increase to $359 by the end of 2016.

Technology Brands To The Rescue

The other most important thing to look out for in this quarter’s report is the growth of the Technology Brands. Whatever strong effort the company is putting in to revive its core business of physical sales of videogame products, they cannot deny the fact that the trend is shifting, and gamers are opting for more digital content. As a result, the company has to focus more on its new business segment: The Technology Brands. The Technology Brands segment has already accelerated its top-line growth, with 70% y-o-y increase in revenues to $102.2 million and 65 net new store additions in the first quarter of fiscal 2015. [7] This led to a substantial 34% y-o-y increase in revenues from mobile and the consumer electronics segment.

By the end of the first quarter, the company had 549 Technology Brand stores, and continuing at this great pace, the company expects to easily achieve its target of 450 to 550 net new Technology Brand stores this year. Moreover, Technology Brands are high margin segments of the company, with strong double digit growth in earnings, and will eventually help the company to generate better profit margins in the coming years.

We expect the total contribution of the digital segment and Technology Brands to cause the net sales to further increase in Q2. The technology sector is probably GameStop’s only wildcard in this present scenario and, if played well, can revive the company’s revenue stream.

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Notes:
  1. July 2015 NPD report []
  2. GameStop Corp. announces second quarter 2015 earnings release date and conference call webcast []
  3. Yahoo finance, GME Q2 2015 estimates []
  4. Ref: 1 []
  5. Ref:1 []
  6. July 2015 NPD sales- Gen 8 console sales up 5% YOY []
  7. GameStop, Q1 2015 earnings call transcript []