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GameStop Earnings: What to Watch

By Demitri Kalogeropoulos – Mar 26, 2018 at 10:17AM

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Investors have big concerns ahead of the retailer's fourth-quarter earnings report next week.

The video game industry may be booming, but that isn't providing much support for GameStop's (GME -8.49%) stock these days. In fact, the niche retailer has dramatically underperformed the market in the past year. And in a demonstration of just how little faith Wall Street has in its future, GameStop's dividend yield recently crossed an all-time high of 10%.

The company will update investors on the sustainability of its payout -- and its outlook for the new year -- when it announces its fiscal fourth-quarter results next week. Here are a few of the important trends to look for in that report.

Sales and profits

Investors already have a good idea of where GameStop's revenue growth landed over the holiday season. In a mid-January update, the company revealed that comparable-store sales shot up by 12% in that critical period, a significant improvement over the 2% growth it managed in each of the prior three quarters.

Two friends playing video games.

Image source: Getty Images.

Surging demand for new gaming consoles like the Xbox One and Nintendo Switch helped, and so did major new software releases like Activision Blizzard's (NASDAQ: ATVI) Call of Duty: WWII. The strong finish to the year should lift its comps growth to roughly 5%  for 2017, compared to an 11% slump in the prior year.

Yet GameStop's sales trends are shifting in ways that aren't beneficial to its bottom line. The retailer's profit margins on new hardware sales are quite thin, and that's its fastest-growing category. At the same time, its sales of pre-owned video games -- a far more profitable segment -- are shrinking. As a result, investors are bracing for another decline in profitability this quarter, similar to the 1.4 percentage point slump it reported in its fiscal third quarter.

Other businesses

GameStop's holiday-season update warned investors to expect major impairment charges ahead. After reviewing its recently acquired business lines, especially the consumer technology segment, it found that those units aren't as valuable as it had originally estimated. Thanks to negative trends like a lengthening cycle for smartphone upgrades, GameStop may have to write down the value of its tech brands segment by between $350 million and $400 million in Q4.

That charge by itself won't be a threat to the business, since it  impacts neither cash flow nor the retailer's liquidity. However, GameStop has been betting on the tech brands segment to cushion it against the pain of a shrinking market for physical video game discs. If that business fails to meet expectations, it will require management to take another look at their long-term diversification plans -- and likely lead them to reduce their earnings forecasts.

About that dividend

If GameStop reports the $3.25 per share of profits that it expects to for fiscal 2017, it will mark the retailer's second straight annual earnings drop. Profits peaked at $3.80 per share in 2015 before falling to $3.42 per share in 2016. Still, that earnings figure would amply support its current annual dividend of $1.52 per share.

GameStop could still choose to reduce or suspend that payout, depending on management's reading of selling conditions for the upcoming fiscal year. Steady sales growth with slight profit declines would allow it to keep the dividend intact if it chose to. On the other hand, if GameStop predicts challenges in its new business lines and an accelerating drop in profitability, it might make sense for the company to shore up its finances in preparation for an expensive restructuring plan. Wall Street appears to be betting on that bleaker scenario. We'll find out whether those worries are overblown in Wednesday's earnings report.

Demitrios Kalogeropoulos owns shares of Activision Blizzard and GameStop. The Motley Fool owns shares of and recommends Activision Blizzard. The Motley Fool owns shares of GameStop and has the following options: short April 2018 $18 calls on GameStop. The Motley Fool has a disclosure policy.

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