GameStop: A Buying Opportunity Or A Stagnant Stock?

GameStop’s (NYSE:GME) core video-game segments have let them down one more time. The specialty video-game retailer posted a Q3 EPS of 54 cents, down 5% year-over-year (y-o-y), as well as net revenues of $2.02 billion, down 3.6% y-o-y. ^[1] Despite the decline in net sales for the software and hardware segments, the company is fairly satisfied with the performance of its pre-owned products segment, and digital business and Technology brands segment. As a result, the company’s stock dropped nearly 5% during the initial trading hours, and is currently trading around $32.50. Let’s have a look how the stock has been trending off lately and what’s in store for the company in the coming holiday season.

Our price estimate for the company’s stock is $38, which is roughly 15% above the current market price.

See our complete analysis of GameStop

Is GME A Good Buy At $32?

GameStop’s stock has returned to the $32 mark after exactly 12 months. The first half of 2015 witnessed a steady increase in the stock price from $32 to $47, primarily driven by an increase in software and hardware sales during the holiday season. Moreover, the company’s Technology Brands business showed tremendous growth during the initial two quarters. However, the stock found it difficult to break through the $50 mark.

In November 2015, the research group NPD released the game sales report, which stated that the video-game software sales were down 3% year-over-year (y-o-y) to $338 million for the month of October, whereas the hardware sales were flat during the same period. The interesting thing to note is that the software sales were down despite the launch of some of the core titles in the industry. ^[2]

As a result, the analysts decreased their estimates for the company’s revenues for its core segments. Consequently, the stock went tumbling down from $44.50 to $37 on lowered estimates. A week later, slower growth in comparable store sales further instilled negative sentiments among the investors, and the stock crawled back towards its $32-$35 range.

The interesting fact about the $32-$35 range for this company is that for the past 3 years, GME stock has rebounded thrice from this range, making it a psychological buying point for investors. In all three scenarios, the stock fell down on a poor sales report, and the company then came up with recovery measures, such as the introduction of value products (below $20 games), new offers on digital content of games, and introduction of the Technology Brands segment. The stock has been receiving a strong resistance at the $30 level. So it is safe to say that a better game sales report for the month of November might provide the necessary push to the stock, and if the stock won’t break the $30 mark, the upward move might be the one with momentum. However, on the other hand, if the industry witnesses a poor November for sales, the stock might even fall below $30.

Core Business Needs Industry-wide Demand To Improve

GameStop’s video-game software sales figure for the first three quarters of 2015 was down 2.5% y-o-y, despite the release of FIFA 16, Madden NFL 16, and Fallout 4 in the third quarter. The decline was mostly on a comparison basis, as last year, the third quarter witnessed a massive launch of Destiny. Moreover, the performance of Halo 5 and Assassin’s Creed fell short of expectations. In the fourth quarter, we expect the popular titles, such as Need for Speed and Call of Duty: Black Ops III, to outperform last year’s fourth quarter. These titles are getting tremendous initial response from the core gamers, and with the console transition almost over for most of the gamers, demand for these software titles might escalate in the holiday season 2015. According to Trefis estimates, the video-game software revenues per square foot will drop just 1% y-o-y in 2015.

On the other hand, GameStop’s hardware sales, through the first three quarters of the fiscal year, dropped nearly 8% y-o-y, due to declining demand for older generation console platforms. Trefis estimates the video-game hardware revenue per square foot to decline by 5% y-o-y in 2015.

Needless to say, the core segment is facing a gradual decline, with the revenue contribution of both the software and hardware segments  dropping from 57% in Q3 2014 to 51% in Q3 2015.

Pre-Owned Products Business and Technology Brands To Drive Margin Growth

GameStop’s margins for the third quarter rose 280 basis points y-o-y to 32.5%, with the pre-owned products segment and new businesses playing a vital role in the margin growth. Pre-owned products segment showed 0.6% y-o-y growth in the third quarter, or 4.9% y-o-y excluding foreign exchange impacts, driven by robust growth in the next generation pre-owned consoles and software titles. Moreover, the margins for the segment were on the higher end of the guidance. ^[3] The company expects the segment to be in line with the guidance for the fiscal 2015, and play a major role in the margin growth for the company.

GameStop’s Mobile and consumer electronics segment posted a 31% y-o-y increase in the revenues for Q3, with the revenue contribution of the segment rising to 8.2% from 6% in Q3 2014. Most of the growth was driven by a 64.2% growth in the Technology brands segment, as the new businesses become a greater portion of the mix. However, the conversion of RadioShack stores to Technology brands stores is taking more time than expected. At the end of Q3, there were 834 Technology brand stores, up 104% from Q3 2014. With the accelerated expansion strategy of this segment and higher margins, there is no doubt that gradually the non video-game segments will overtake the core business in revenue and profit contribution.

Considering the fact that the pre-owned products segment and Technology brands are expected to outperform in the coming quarter, as well as the anticipated revival of software sales in the holiday season, we might witness the stock bounce back to the higher end of $30-$40 range over the coming quarters.

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1. GameStop, Q3 2015, earnings call transcript [↩]
2. October 2015, NPD report [↩]
3. Ref: 1 [↩]