GameStop Q3 2015 Earnings Preview: Can New Business Segments Overshadow Core Segments?

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The video game retailer, GameStop (NYSE:GME), is scheduled to report its third quarter earnings result for the fiscal 2015 on November 23, 2015. [1] Over the last two quarters, the company has been posting better-than-expected results, beating market EPS estimates by a wide margin, and impressive revenue growth across all segments. The highlights from the quarterly earnings results are the double digit revenue growth in the Technology brands segment and impressive new store development. We expect the company to outperform market expectations in these two aspects. Nonetheless, the investors are more worried about the fact that the stock is not appropriately reacting to the results. A few drivers that will be the center of attraction in this earnings report are: growth of Technology Brands, performance of the core segments, and guidance for the fiscal year 2015.

Our price estimate for the company’s stock is $40, which is slightly above the current market price.

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Core Segments Need To Improve

The gaming industry has recovered from last year’s situation, where software sales were lagging. It was estimated that the situation might worsen this year. However, the sales data provided by NPD group indicates that the scenario has improved dramatically. Contradictory to the expectations, the software sales for the first 10 months of 2015 is roughly the same as that over the same period last year, despite the declining demand of old generation console platforms (PlayStation 3 and Xbox 360). [2]

software sales

Moreover, in Q3, the industry witnessed the release of some of the blockbuster titles, such as Destiny: The Taken King, FIFA 16, and Madden NFL 16. These titles will surely provide a boost to the company’s new video-game software revenues. Apart from these titles, some of the last year’s core titles, 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, were still in strong demand, among the respective game lovers in Q3.

Trefis estimates the new video-game software revenue per square foot to increase 1% year-over-year (y-o-y) in 2015.

On the other hand, GameStop’s hardware segment might witness another disappointing quarter, as most of the gamers shifted to new generation console systems and the demand for previous generation consoles declined tremendously. According to the NPD report, the combined hardware sales figure for the ten month period of the year 2015 is down roughly 9% y-o-y. [2] With some of the AAA titles releasing in Q3, we might see an improvement in the hardware sales. Trefis estimates the new video-game hardware revenues per square foot to decline 1% y-o-y in 2015.

Technology Brands: Expecting An Exponential Growth

Perhaps the highlight of this quarter earnings result will be the top-line performance of the Technology Brands segment. As the gamers are shifting towards digital gaming, Technology brands might be the future core business for the company. The revenue contribution of the core segments (Software, hardware, pre-owned, and value products) has dropped from 80.1% in Q2 2014 to 76% in Q2 2015. This indicates the increasing dependence of GameStop on its new business segments. The segment has already accelerated its top-line growth, with 27% y-o-y increase in revenues to $142 million and 182 net new store additions in the second quarter of fiscal 2015. [3]

gme rev

The contribution of these new businesses to the company’s gross profit rose from 18% in Q2 2014 to 23% in Q2 2015. As a result, the net gross margins for the company rose to 32.9%. Considering the current pace of the segment’s growth and future prospects of the business, we might expect further growth in the margins in the coming couple of quarters.

Guidance Can Play A Vital Role

The company mentioned in its Q2 earnings call that it expects a comparable store sales growth in the range 1% to 4% for the third quarter, and 2% to 7% growth for the full fiscal year, raising its initial guidance of 1% to 6% growth. Additionally, diluted EPS is targeted to be in the range 53 cents to 60 cents for Q3.

The investors are expecting the company to achieve the higher end of the target spectrum. Moreover, all eyes would be on the guidance for the fourth quarter. An all-round performance from all the segments might even lead to a further increase in the comparable sales growth targets.

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Notes:
  1. GameStop, Q3 2015, earnings conference call []
  2. October 2015, NPD game sales [] []
  3. GameStop, Q2 2015 earnings call transcript []