GameStop (GME 1.50%) is making an appeal to young gamers with 80 kid-themed stores, which it plans to open in preparation for the holiday season shopping surge. The stores, called GameStop Kids, will be stocked with popular toy and video game brands, including Angry Birds and Lego. This is a small but smart move that should contribute to a better holiday season for the struggling retailer.
GameStop knows that young video game players are a rare bright spot in the gaming space. Game publisher Activision Blizzard's (Nasdaq: ATVI) recent results are a perfect example. The maker of the epic Call of Duty and Diablo franchises has a real hit on its hands with Skylanders, the kid-targeted title that was recently named the highest-grossing console game in North America and Europe. Electronic Arts (EA 0.02%) has seen a similar trend in its business, with casual and subscription-based games, including its Sims and PopCap brands, growing to a significant portion of total revenue.
By contrast, older gamers, who tend to flock to new technology and cutting-edge graphics, are buying fewer titles as the current generation of consoles continues to age. They've instead been scooping up tablets and smartphones and funneling their gaming purchases through Apple's and Google's app stores. NPD's latest survey of the industry confirmed that the overall gamer population fell this year, with the number of so-called "core gamers" shrinking while the ranks of mobile and digital gamers continued to swell.
GameStop was far from immune to that shift. The company reported another drop in comparable store sales last quarter, of nearly 10%. That followed the 12.5% fall in Q1 of this year. And in last year's all-important holiday quarter, GameStop booked a painful 20% drop in hardware sales, which it attributed mainly to "weak Wii software sales and hardware sales due to the lack of new hardware offerings." The company's sales of previously owned merchandise helped cushion the fall, but without any exciting new hardware to offer, GameStop could manage only flat comparable-store-sales growth over the previous holiday period.
But the company's prospects are a bit brighter this year, even without a full refresh of the three major game consoles. GameStop can count on a boost in traffic from next month's launch of Nintendo's (NTDOY -0.41%) Wii U -- the first next-gen console in six years. Initial orders suggest that there's quite a bit of pent-up demand out there, as GameStop has already sold out of its allotted first wave of preorders and boasts a waiting list for the Wii U, with more than 250,000 names on it.
Most encouraging for GameStop is that, because of Nintendo's prior success in nabbing the exact gamer demographic that's been flocking to mobile gaming for years, the retailer has good reason to expect that a strong Wii U launch can bring those gamers back into its stores. And tailoring directly to younger players connects well with that strategy. Still, considering the company's large footprint of more than 6,600 locations, GameStop's 80 new kid-friendly stores won't have much direct impact on revenue.
Yet with a new console on deck -- aimed at an important demographic -- GameStop may finally notch sales gains starting next month. And that prospect suggests that the selling pressure on GameStop's stock has gone too far. Shares are valued at less than 10 times earnings, near historic lows for the company and on par with Office Depot (ODP 4.85%), another specialty retailer that's been reporting declining sales lately.
That's far too low a valuation for GameStop's business. Unlike Office Depot, GameStop is expanding its national footprint, not retreating. The company also reported a healthy $600 million in cash flow last year, or three times Office Depot's haul. And it has been booking higher gross margins, to the tune of an additional 2% per quarter, for five consecutive quarters. Plus, GameStop just boosted its dividend payment by 67%, to an annual yield of more than 4%. That looks like an attractive value to me, with the added potential for significant upside should the company manage a strong holiday season this year.
