GameStop (NYSE:GME) was one of last week's biggest losers. Shares plummeted 29% for the week, after the small-box retailer of video games announced that it was abandoning plans to put itself up for sale. The stock hit a 13-year low on Thursday, closing out the week more than 80% below its late-2013 highs and its all-time peak in 2017.
As cruel as it's been to be a GameStop shareholder in recent years, it wouldn't be a surprise to see at least a small bounce here. GameStop's yield -- up to a record 13.5% -- is going to smoke out more than a few income investors that can stomach the risk. Bears will argue that GameStop's business is in a death spiral, but with the chain's healthy profitability and a cash-rich balance sheet saddled with manageable debt, there will be short-term opportunities for bulls to win on this slow road to obsolescence.
Playing a new game
The obituary for GameStop has been written years ago. The shift to digital delivery has put physical game discs and cartridges on the endangered species list. Developers are cutting out the middleman, establishing direct relationships with diehard gamers. New games are still coming out, but that's no longer the only way that publishers are getting paid. There's also the mobil revolution, as casual gamers shift from consoles to tablets and smartphones for cheaper and more portable diversions.
The trends are problematic for GameStop. Its highest-margin business has always been the resale of preowned games, but that market's future is hazy as more people are buying digital games and add-ons that can't be traded in to GameStop for in-store credit. The appetite for hardware and accessories remains strong, but consoles have historically commanded the lowest margins in GameStop's arsenal.
The good news for knife catchers here is that GameStop may be breaking but it's not broken. Revenue grew in its latest quarter, posting its first period of positive comps in more than a year. Adjusted earnings clocked in lower -- as a 13% decline in pre-owned sales ate into the lower-margin growth in new hardware and software sales -- but the point here is that GameStop remains very profitable. GameStop did slash its outlook in November, and after a mixed holiday showing, it's sticking to its target of adjusted earnings per share of $2.55 to $2.75 for the fiscal year that ended last week.
GameStop's model is still generating gobs of free cash flow. GameStop has done the right thing with those proceeds, returning it to its shareholders in the form of buybacks and dividends as well as diversifying into collectibles and wireless services. It seemed to be pivoting away from that last month when it closed on the $735 million sale of Spring Mobile, but that was when it figured it was still smoking out potential suitors. The silver lining in the sale is that it will beef up an already healthy balance sheet, if it doesn't provide more ammo for buybacks or new ventures.
There is little reason to get excited about GameStop's long-term prospects, but it should have moments where it does push higher. Though the stock will likely be lower in five years, it wouldn't be a surprise to see it navigate its way higher in 2019 from its current deeply discounted starting line.
Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool owns shares of GameStop and has the following options: short July 2019 $18 calls on GameStop. The Motley Fool has a disclosure policy.