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Don't Expect Much Good News From GameStop on Thursday

By Demitri Kalogeropoulos - May 30, 2018 at 11:00AM

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The retailer is facing major sales and profit challenges, complicated by its lack of a permanent CEO.

Earnings announcement days haven't been good lately to shareholders of GameStop (GME -4.79%). Instead, investors have hammered the specialty retailer's stock for more than a year, and now value it at the fire-sale price of just four times expected profits.

That depressing valuation could set the stage for a big rebound in the stock when GameStop posts fiscal first-quarter earnings results after the market closes on Thursday, May 31. However, it's not likely that the retailer will show significant improvements, either in its operating results or its finances.

Two kids playing video games.

Image source: Getty Images.

Let's look at what shareholders can expect from the report.

Sales and profits

GameStop managed robust sales gains over the holiday season, with revenue spiking 12%. That success allowed comparable-store sales, or sales at existing locations, to rise 6% for the full year and beat management's initial target by a healthy margin.

But look behind that top-line growth number, and there are good reasons for pessimism. GameStop's expansion has been powered by sales of new hardware devices,  particularly the Nintendo Switch. There's no comparable gaming release in early 2018, and so the retailer should have trouble reporting much growth this quarter, especially since its pre-owned video games and consumer tech segments aren't seeing robust gains. Overall, GameStop is projecting a 3% sales drop at the midpoint of its guidance range.

The profit outlook is even worse. GameStop saw its gross margin plunge to 29% of sales last quarter from 33% a year ago. And there's no reason to expect that trend to improve dramatically, since its sales are shifting away from highly profitable pre-owned games and toward game hardware.

GME Operating Margin (TTM) Chart

GME operating margin data by YCharts. TTM = trailing 12 months.

Executives said in late March that they were disappointed with the earnings performance of both the pre-owned gaming segment and the tech brands division. That's why investors will be looking for initial signs of improvements coming from GameStop's new efficiency strategy.

About that dividend

GameStop's initial 2018 outlook called for its third straight year of falling earnings as profit stops at between $3 per share and $3.35. It's never good news to see earnings slump over long periods like that, but the retailer's forecast isn't exactly bleak.

For example, that profit target would leave plenty of room to support the retailer's hefty dividend that today yields over 11%. Its payout is just $1.52 per share, or less than half expected earnings. The dividend is well covered by operating cash flow, too, which amounted to over $400 million last year, compared to an annual dividend outlay of about $155 million.

Of course, executives could decide to slash that payout as part of their new focus on shoring up GameStop's finances. And the pressure to make such a move would increase if profitability takes another turn lower this quarter.

Strategic updates

Finally, look for GameStop to update shareholders on its search for a new leader after Michael Mauler resigned just three months into his role as CEO.

It's understandable that the retailer would struggle to fill this position, since the incoming boss will face major challenges led by weak demand in the core video game segment and an underperforming tech brands division. These issues threaten GameStop's plan to diversify away from the shrinking video game market, while protecting its earnings power and keeping sales marching higher.

That diversity isn't evident in the company's latest results, and in fact management has warned that as much as 90% of 2018 earnings will be generated in the third and fourth quarters of the year. As a result, investors likely won't have a good gauge on GameStop's financial health until the peak holiday selling season is underway.

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