GameStop's 8% Yield Really Is Safe

|
About: GameStop Corp. (GME)
by: Josh Arnold
Summary

GME continues to get crushed.

But the yield is still around 8%.

And with it being more than 200% covered by FCF, it is too much to pass up.

Photo credit

GameStop (GME) has been quite the battleground stock of late. The company’s constant struggle with the very existence of its business model has taken its toll, however, and the stock continues to get hammered. At its current price of $19, it is yielding about 8%, which is out of this world for an equity outside the income-driven worlds of BDCs, REITs, etc. With the stock being beaten down like GME will eventually go out of business, the dividend is rightly part of the conversation. After all, when stocks yield 8% it usually presages some sort of impending doom. But in GME’s case, that just isn’t how things are.

To demonstrate this, I’ll be using data from Seeking Alpha.

We’ll begin with a chart that shows GME’s considerable dividend cost against its ability to produce FCF. The chart shows the past five full fiscal years and the reason I like this metric is because a dividend is a cash outlay that must be physically funded by FCF (preferably), debt or something else. Thus, the best, most robust dividends are those that are fully funded and then some by FCF. Companies that cannot produce enough FCF to fund their dividends must fund it via debt or asset sales, both of which necessarily have finite life spans. However, in GME’s case, that is nowhere close to being an issue.

We can see that despite the fact that GME’s dividend is about 8%, it is less than $160M per year in cost. That’s a very manageable sum for GME as it produces roughly $400M annually in net income, and has done about that well with respect to FCF. In what is pretty normal across many industries, FCF is very lumpy for GME. We see $500M in 2013, better than $600M in 2014 but only just over $300M in 2015. The point, however, is that over time, GME’s FCF dwarfs its dividend cost on average and that is the sweet spot for a dividend stock. The fact that GME’s yield is so high but takes up such a tiny proportion of its FCF is absolutely astounding, but as I said, the stock is being written off by investors. Combine that with an enormous FCF yield and you get the above with an 8% yield.

Seen another way, the chart below shows the proportion of FCF the dividend has consumed over the time period above to get us a bit clearer picture of just how good GME is in this area.

The worst year in this dataset is 2015 when GME was still under 50%. Otherwise, a normal year is a third or less of GME’s FCF, with it ticking up over the past couple of years. Even last year, the dividend was just 39% of its FCF, which is just half of the level where I begin to get concerned. Companies that spend “too much” on their dividend are at 80% or more on this metric, which means their financing flexibility is tremendously reduced by their overspending on the dividend. After all, if cash is being used almost exclusively to fund the dividend, things like additional capex, acquisitions, share buybacks, etc., cannot be funded in the same way. Again, with GME at just 40% or so, its dividend is considered ultra-safe, which is in stark contrast with what you’d probably think if you just took a look at the stock chart.

This year, FCF is negative by a few hundred million dollars, but keep in mind that GME’s meaningful period is the second half. To be honest, trying to predict what the whole year will look like from the first two quarters is an act in futility, so I won’t bother. But even if FCF gets cut in half from last year – literally, cut in half – GME’s dividend is still safe. It certainly wouldn’t be in the terrific shape it is in today, but it could work.

Now, what does this have to do with the stock? I think it has quite a bit to do with it because unless you think GME is going out of business – I don’t – the dividend is a huge draw. There are very few places you can get an 8% yield that is also consuming less than half a company’s FCF; it is honestly something I’ve never seen anywhere else before. Thus, if it is income you’re after, you can do so much worse than GME. Investors for years have been overpaying for consumer staples that yield 2.5% or something while GME rots with its 8% yield that is doubly as safe the staples' yields. Yes, there is risk to GME’s business model, but even so, there is such a margin for error here that if the dividend does get into trouble, you’d have ample time to get out. For that reason, I have to stick with my dividend-driven recommendation of GME; it is just too juicy to pass up given how safe it is.

As outlined in my recent article on GME, the company is adapting to a changing landscape, and while there are risks to the model, it is picking up the slack of weak software sales with hardware and other smaller categories. In addition, the non-US business is flying and produced a nearly 10% comp last quarter. This is not a low-risk position, but with a PE in the area of 6 and an 8% yield, the odds are stacked in your favor. It would take another significant deterioration in the business for some sort of bankruptcy situation to enter the discussion and I just don't see it. What I do see, however, is an enormous yield and an absurdly cheap valuation.

Disclosure: I am/we are long GME. 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.