Shares of GameStop (NYSE:GME) recently plummeted after the video game retailer disclosed its holiday sales numbers. That drop was surprising, since the headline numbers looked solid.
Its total sales for the nine-week holiday period rose 10.6% annually to $2.77 billion, and its comparable store sales rose 11.8%, fueled by robust demand for the Nintendo Switch and Xbox One X.
After its recent drop, GameStop's stock is now down more than 20% over the past 12 months. Therefore, contrarian investors might be wondering if GameStop can rebound this year.
5 reasons to buy GameStop
GameStop looks cheap at 5 times earnings, which is much lower than the industry average P/E of 50 for specialty retailers. It trades at just 5.5 times next year's earnings.
GameStop pays a hefty forward dividend yield of 8.6%, which is well-supported by a low payout ratio of 44%. The company has hiked that dividend every year since its inception in 2012.
The bears often argue that digital distribution platforms will kill GameStop's business model, but only 48% of its revenues came from sales of new or pre-owned physical games during the holiday period compared to 52.5% a year earlier. The rest came from digital sales, gaming hardware, accessories, collectibles, and consumer electronics.
GameStop's top line growth is improving, and it reported positive annual sales growth in its gaming hardware, new software, collectible, and "other" revenues last quarter. New hardware and software sales also rose during the holiday period.
Analysts expect GameStop revenue to rise 4% this year, compared to an 8% decline in fiscal 2016. GameStop expects its full-year comps to rise 4%-6% -- so the company isn't down for the count yet.
GameStop partnered with Amazon (NASDAQ:AMZN) last year to let customers trade in their pre-owned products for AmazonCash, which can be spent on other Amazon products. That partnership might benefit Amazon more, but it could convince customers to keep visiting GameStop's brick-and-mortar stores.
5 reasons to sell GameStop
However, GameStop is losing its footing in a few key areas. Last quarter, its sales of pre-owned products, video game accessories, digital games, and technology brand (consumer electronics) revenues all fell year-over-year.
Its drop in pre-owned product sales indicates that its Amazon partnership isn't a magic bullet, declining digital sales indicate that it's still struggling to counter bigger digital distribution platforms (although that figure rebounded during the holiday period), and declining tech brand sales indicate that its plan to offset waning game sales by selling iPhones isn't paying off.
That bet on mobile devices was a costly one, since GameStop spent hundreds of millions -- mostly raised through a debt offering -- to fund its purchase of over 500 AT&T (NYSE:T) Mobility stores for that purpose in 2016. GameStop should probably have spent that capital on expanding its collectibles, e-commerce, or digital efforts instead.
GameStop's bottom line growth remains weak. During the holiday update, it disclosed that it will take an impairment charge of $350-$400 million during the fourth quarter due to the weakness of its tech brands business. The company attributed that softness to slowing smartphone upgrades and changes in AT&T's compensation structure.
As a result, GameStop expects its full-year earnings to fall 10%-18%, compared to analyst expectations for an 11% decline.
GameStop's new gaming hardware sales rose nearly 9% annually last quarter, making it its fastest-growing business. Unfortunately, that business also has the lowest gross margin (10% on a trailing 12-month basis) of all its business units.
Meanwhile, revenue from the three businesses with the highest gross margins -- digital games (86%) technology brands (70%), and pre-owned and value games (46%) -- all declined last quarter. Simply put, GameSpot is growing, but in all the wrong places.
The verdict: Avoid GameStop (for now)
Looking ahead, GameStop faces tough headwinds from digital distribution platforms, sluggish mall traffic, slower upgrades for mobile devices, and the widespread availability of collectibles on Amazon and other e-tailers. Therefore, I believe GameStop is still more of a value trap than a value stock.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon and AT&T. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of GameStop and has the following options: short January 2018 $19 calls on GameStop. The Motley Fool has a disclosure policy.