GameStop: Armageddon

| About: GameStop Corp. (GME)

Summary

A few months ago I wrote about the so-called "death of GameStop" but gave it a buy rating.

I missed the chance to buy.

I discuss the harrowing results but why I am positive.

A few months ago I wrote about the so-called "death of GameStop" (NYSE:GME). Of course, I have a long-term buy rating on the name. Once again I am being asked about this controversial name before our Thanksgiving holiday. At this stage of my life I am just a casual gamer who plays here and there or with my children. I am officially an adult and sometimes that is depressing. What is ironic is that being an official adult who works hard and chases the American dream, I have the cash flow to afford places like GameStop. As a business I love the GameStop model. Buy and sell games, have membership fees, sell game-related merchandise, own a digital service and compete with major retailers. Sell products to a select but powerful lobby of gamers and keep it fresh. It is certainly a strong niche to be in.

Now, it has been a very rough time for the industry. There are no major hardware releases that I know of and it has been years since the latest 'must-have' console. Of course the money is made in the software, in terms of margins, but even here the cycle is in a downtrend. Does this mean it is time to buy? As a reminder regarding the stock, the name trades at just 6.3 times current earnings and is now yielding north of 6%. That attracts me immediately and frankly I wish I bought two weeks ago. I did not have it on my watchlist for some reason despite telling you previously I wanted to get in under $25 as close to $20 as possible. I got that chance, but admittedly, 'dropped the controller' playing this one. Never quite got to pull the trigger. Now I am eyeing the name once again. Despite the name seeing sales declines, which is due to a tough retail market and where the video game cycle is, I am strongly considering initiating a position in the name again, as the yield is attractive. The way I see it, you get paid to wait. Don't miss out. But is the dividend sustainable?

To answer this question, I turn to the just reported results for Q3. Let me get right to the point here. The headline numbers were pretty so-so, but the guidance is still a concern. The company saw sales of $1.96 billion in Q3, which were down 3% year-over-year, and missed analyst estimates by $30 million. Earnings came in at $0.49 per share and actually beat estimates by $0.02. So does the name have brighter days ahead? Let us check in with the specific data points to get a feel for performance.

I will be up front here. If I wasn't familiar with the gaming industry cycle, the results appear to be Armageddon for an investment. Many key indicators were resoundingly negative. Same-store sales is a key indicator. They were down 6.5% compared to down 1.1% last year. That hurts. Very weak. Of course, despite earnings beating estimates, they were down 7.5% year-over-year on a per share basis. What is the deal here? One big eye sore stands out and I alluded to it above. New hardware sales declined 20.6%. On top of that, software sales were down 8.6%. Pre-owned sales also struggled, down 6.4%. These results are indeed poor.

Digital revenue continues to be a major strength for the company. In fact digital revenue sources rose 13% to $259 million. The company's technology brands jumped 54% to $216 million. Digital content represented 24% of operating earnings. That is a major and growing segment to watch. While the company recently picked up ThinkGeek, it helped collectible sales spike 37.3% to $109.4.

While the report thus far seems decent, barring the sales declines, what is really a bit nerve-wrecking is the guidance. Again, this reflects the cycle. For Q4 2016, GameStop expects disastrous comparable store sales to range from -7% to -12%. Ouch. Let me repeat, negative same store sales that might be negative double-digits. That is not good. Of course it is the holiday season. Diluted earnings per share are expected to range from $2.23 to $2.38. And for the fiscal year 2016, the company is reiterating its full-year diluted earnings per share guidance of $3.65-3.80. Comparable store sales were revised downward to a range of -6.5-9.5%. Now, despite the weakness, this is part of the cycle. The company is reinventing itself slowly. I think considering that the dividend is more than covered and the company continues to grow through acquisitions, the stock is a bargain, especially with the yield over 6%. I maintain a long-term buy rating, despite the scary guidance. Think bigger.

What do you think? Are you a buyer? Are you short? What do you think of the yield here? Let the community know below.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "Follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GME over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.