Every week in this space, I recommend a stock that investors should consider dumping from their portfolios. Every week, I also nominate three stocks to take its place.
I ruffled some feathers last time around, when I suggested that the leading video-game retailer is starting to take on the paunch of the bloated DVD-rental dinosaurs. Now I'll take that suggestion one step further this week -- and probably ruffle even more feathers -- by making that rapidly growing chain the focus of this week's installment.
Come on down, GameStop (NYSE: GME ) .
As a video-game buff -- and the father of two boys who are growing into diehard gamers -- I've spent plenty of time in GameStop stores. I'm not exactly a fan, since I prefer to pay less than retail through online stores, but I'll concede that GameStop works in a pinch. It's convenient, the staff is typically knowledgeable, and the selection of games is pretty good for a footprint as small as its stores have.
Unfortunately, that's about as good as it gets for GameStop. The latest gaming craze involves musical simulation games with bulky drum and guitar controllers, and that trend is posing a serious challenge for GameStop.
In an interview with MTV Multiplayer this month, a GameStop executive discussed the challenge the bigger packages pose. They're forcing GameStop to consider larger stores and offer drop-shipping of high-end drum sets that won't be available for sale in the actual stores. The alternative would be reduced inventory, which would make GameStop worse than your local Hollywood Video, because at least the shift from VHS tapes to smaller DVDs helped boost in-store inventory levels.
That's not the only reason I'm lukewarm on GameStop this week:
- Digital delivery lies at the heart of connectivity in all of the next generation of video-game consoles and handhelds. As software developers reach out directly to the consumer, isn't GameStop the odd chain out?
- Bulls will argue that GameStop can survive digital delivery because a good chunk of its business comes from selling used games and gear. Patrons trade in tired titles and systems, in exchange for in-store credit. That makes for a higher-margin business than if it sold the new stuff. But let me offer up CarMax (NYSE: KMX ) as a cautionary tale. The used-car specialist saw its comps slide by a whopping 17% this past quarter. What's my point? CarMax bulls used to believe that the company's resale niche would hold up in a weakening economy. Cars aren't games, but either GameStop will have a glut of used gear, or consumers will take their stuff elsewhere, since they don't have the money to add to a trade-in for something new.
- GameStop is showing no signs of slowing. Sales and earnings climbed 35% and 162%, respectively, in its latest quarter. That's nothing shabby, but think about the growth spurts that investors have grown used to lately. When the trend turns, things will get ugly.
Add it up, and you have a company with a product-mix conundrum, facing the threat of obsolescence with digital delivery, and promoting a resale service that may not be as recession-resilient as investors think.
As I have every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
- Take-Two Interactive (Nasdaq: TTWO ) : If digital delivery is the future, Take-Two will be at the wheel. The company already scored a $50 million deal with Microsoft (Nasdaq: MSFT ) to deliver a pair of episode follow-ups to its Grand Theft Auto IV juggernaut. Meanwhile, BioShock is getting the Hollywood theatrical treatment. Take-Two is now just trading at just eight times this year's projected profitability, a pittance compared with its slower-growing rivals.
- Apple (Nasdaq: AAPL ) : Digital distribution isn't just limited to consoles, portables, and computers. Some of the top-selling games through the iPhones App Store marketplace include EA's Spore Origins, Vivendi's Crash Bandicoot Nitro Kart, and THQ's (Nasdaq: THQI ) Star Wars: The Force Unleashed. If consumers are playing games on their smartphones, that means less direct sales for physically distributed titles through GameStop.
- Best Buy (NYSE: BBY ) : This is GameStop with the flexible superstore space to expand. Not only does Best Buy have room for all of the Rock Band and Guitar Hero: World Tour gear, but it's even adding a healthy collection of real musical instruments to some of its stores. Best Buy is also the only third-party retailer selling iPhones, and that rubs even more salt into GameStop's open wounds.
GameStop is clearly on a roll right now. It may take a few quarters for some of these factors to take a toll. I'm also seeing this differently than the Motley Fool Stock Advisor analyst team, and that's a group that knows its stock-picking.
However, I have to play the game as I see it. I have to approach GameStop the stock the same way I do GameStop the store. It looks nice, but I know I can find better deals elsewhere.
Other headlines out of the weekly trash bin: