GameStop: Cool Story Bro

| About: GameStop Corp. (GME)
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I told you previously about the disgusting holiday sales.

This is an income name, so you have to pick the best spots.

Q4 earnings are out and I discuss the critical metrics.

What must happen.

You may recall when I talked about GameStop (NYSE:GME) being simply disgusting given the beating it was going to take following weak holiday sales. Yes, I have felt that as this stock approaches the $20 mark it is a long-term buy. This buy would of course really only be for the purpose of income, as the business is changing. Right now the name is in a holding pattern as the core business faces immense competition and the brick and mortar stores deal with declining traffic. I have stated decidedly that "I don't expect growth until a few years after the new consoles" are out. Now look. Some have compared the name to Blockbuster, or even Kodak cameras. I definitely see the parallels, but I don't think that GameStop is heading to extinction. The bear case is strong, no doubt. I happen to love the business model, but love for gaming doesn't translate to financial gain. There are prevalent fears that GameStop has no real growth prospects, or worse, that it will be entirely cannibalized by the competition. What I mean by the latter is that those who purchase games may simply buy them from competitors like Amazon (NASDAQ:AMZN) or big box stores.

It is not however all doom and gloom. The company is diversifying away from just standard gaming. I will argue however that it needs to really invest in keeping traffic in the stores. The arguments about folks buying video games where the best deal is happens to be true. This is why GameStop must work to make its Pro Membership on par with other programs that sometimes offer 10-20% off a new game. Further, I want to reiterate that we must be aware that the digital trend (downloading games rather than buying a CD) is both a blessing and a curse. This is because more digital games mean less physical sales. While downloading is becoming more popular, GameStop is selling many of those types of products itself. Now I already covered how poor holiday sales were. The stock is taking a beating because performance was poor. To me, it doesn't make sense. The name should have sold down before this, because the weakness was known. It was a terrible quarter but I was not surprised, because we knew how bad sales for the holidays were. So let's talk about this.

Keep in mind, however, where we are in the video game cycle. If you don't understand the video game cycle, then these numbers are bleak. Yes a lot of this is that GameStop is being outcompeted. True statement. Cool Story Bro. But there is a decline in video game sales. In the next few years, there will be a glut of major hardware releases. Of course, it is not hardware that drives sales and profits, it's the gaming/software and accessories. But to sell software, you need the hardware. A new cycle may be starting soon and we have data that supports the notion. The new Nintendo (OTCPK:NTDOY) Switch is doing well this month. In fact, it comes out March 3rd. The Sony (NYSE:SNE) PlayStation 4 Pro and the Virtual Reality are a bit of a stop-gap filler to take advantage of 4k UHD TV sales. There is a potential 2018 release for a new PlayStation system and/or a new Microsoft (NASDAQ:MSFT) Xbox, although there is no clarity. But these new consoles will drive action. So how are things in the mean time?

Let me get right to the point here. The headline numbers were pretty so-so, but the guidance is the biggest concern. The company saw sales of $3.05 billion in Q4, which were down 13% year-over-year, and missed analyst estimates by $50 million. Earnings came in at $2.38 per share and actually beat estimates by $0.09. That was pretty strong. Why were sales down? In part due to intense competition, and in part due to where we are in the gaming cycle. Facts. Those are facts. Here is another fact. In one quarter the company has earned almost twice its dividend paid out. That dividend is safe. 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 another Armageddon scenario for an investment. Many key indicators were resoundingly negative. Same-store sales is a key indicator. They were down 16.3%. This includes being down 20.8% in the United States shops. Wow. That hurts. Very weak. Of course, despite earnings beating estimates, they were down 1% 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 29.1%. Why? Everyone already has the consoles that are out. Duh. Hello. Video Game Cycle. On top of that, software sales were down 8.6%. Pre-owned sales also struggled, down 19.3%. That is due to a lack of strong new titles, and again, reflective of lack of new consoles. Regardless, from an investment standpoint, these results are indeed poor.

Where is the strength? I will tell you that digital revenue continues to be a major asset for the company. However, with a move to selling digital games, the weakness persisted here as well to my surprise. In fact digital revenue sources fell 7.7% to $374 million. The company's technology brands jumped 44% to $256 million. While the company recently picked up ThinkGeek, it helped collectible sales spike 27.8% to $212.4 million.

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 2017, GameStop expects comparable store sales to range from -5% to flat. Ouch. Let me repeat, negative same store sales are likely. That is not good. Diluted earnings per share are expected to range from $2.23 to $2.38. Now the bleeding in total sales is expected to be quelled somewhat, with revenues coming anywhere from down 2% to up 2%. It is eyeing net income however of just $320 to $354 million, with earnings of $3.10 to $3.40.

Can you buy now? Well, if you believe in the cycle, then yes, brave souls could be in buying. I have said as the closer to $20 the better. The dividend is more than safe and offers a bountiful 7% yield. Despite these negative trends over the last two to three years, the payout has been hiked and earnings easily cover them. Since I recommend a buy as an income name, GameStop will be a win even if the stock remains flat. However, let say you bought in at $25 and the stock remains at $20. It is going to take 4 years to recoup losses from the dividends. So be mindful. There are a lot of better investments in this market I can assure you. However, I don't buy into the name going the way of blockbuster. GameStop is too specialized. But it must adapt, or else it will not survive. Let us keep an eye on the name and see where it goes. If it manages ineffective stores well, can shore up its Pro membership, diversify into other sales and keep costs competitive, it will be around for years to come.

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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.

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