GameStop (NYSE:GME) recently provided an update on its results for the first fiscal quarter (the period ending in early May) in the wake of the novel coronavirus. As expected, same-store sales (comps) cratered, falling 23% for the first nine weeks of the quarter. One bright spot that management pointed out was that U.S. comps were up 3% in the first three weeks of March (just prior to the store closures), but this is too short a period of time to draw any conclusions.
The company has about 5,500 stores across the globe, but two-thirds are located in the United States. Out of the more than 3,600 U.S. stores, two-thirds have continued to offer curbside pick-up. These have retained over 90% of the company's planned sales volume after the pandemic forced store closures.
While the pandemic has affected sales, it is unfair to judge the company's performance based on this very unusual period. In the interest of fairness, I looked back at the company's performance before measures were taken to halt the spread of the coronavirus.
Business pointing down
Simply put, GameStop's sales performance has been poor for the last several years. This includes a 19.4% comp sales decrease in fiscal 2019.
Management blamed the soft sales on a variety of factors. Much of the weakness was due to the game-console cycle, since Microsoft and Sony are scheduled to launch new systems in late 2020. However, that doesn't entirely explain the sales drop. Software sales, which represented 46.5% of GameStop's fiscal 2019 top line, have been falling for the last few years. Last year, software sales fell by 22% to $3 billion. This was partly due to closures of underperforming stores, but most of the decline in software sales came from lower comps. There were fewer physical games released last year, and they didn't sell as well as in fiscal 2018.
While GameStop may see sales perk up when the new gaming consoles hit the market, the company will continue to lose out on selling games as the trend toward digital downloads accelerates. Microsoft already has a version of its gaming system -- Xbox One S All-Digital Edition -- that doesn't have a disc slot at all. Instead, it supports downloaded games and streaming content. Also, Sony has a subscription-based service allowing subscribers to download games.
There are many other companies, big and small, that offer online games. This means there is a large and ever-growing threat to GameStop's sales.
The good news is that GameStop's gross margin expanded in fiscal 2019 from 27.9% to 29.5%. Management credited a mix shift away from lower-margin gaming consoles -- which will likely prove fleeting after the new ones are launched -- and better inventory management that resulted in lower promotional activity. While the gross margin increase is nice to see, GameStop needs to make more progress on turning around its operations.
An activist in the midst
The company's performance led management to implement the GameStop Reboot turnaround plan in 2019. This involves steps like cutting costs and building out GameStop's omnichannel capabilities.
While adjusted selling, general, and administrative costs fell by $130 million to $1.85 billion last year, and the ability to order online and pick up items at the store has no doubt helped sales in the first quarter, these moves are not driving higher profitability. Last year, GameStop's adjusted operating income fell by 81% to $62.3 million. With weakening sales and profitability, GameStop's shares have fallen by 84% over the last five years.
It's no wonder that the company has attracted the ire of an activist investor group that owns more than 7% of GameStop stock. Hestia Capital and Permit Capital are seeking two seats on GameStop's 10-member board of directors. The activist group wants its board representatives to push for cost-cutting, executive compensation changes, liquidity enhancements, and better utilization of GameStop's gaming platform.
I think the company needs a change, but the activists haven't provided many specifics about how they would change GameStop's course. The challenge is a steep one, due to the unmistakable trend toward digital game downloads, making it hard to see how GameStop will reinvigorate its business. For me, this is a game not worth playing.