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GameStop Is Cash Rich but Growth Poor

By Demitri Kalogeropoulos – Sep 12, 2020 at 11:00AM

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The chain is hoping the next-generation console switch will spark a sales rebound.

Investors weren't expecting positive operating news from GameStop's (GME -4.07%) second-quarter earnings announcement. The specialty retailer is being pinched by reduced customer traffic due to the pandemic, and by slumping demand in anticipation of the release of next-generation gaming consoles.

Wednesday's earnings report didn't show much progress in the chain's attempts to grapple with those challenges. But GameStop still managed to improve its cash standing while reducing its financial risk heading into the holiday shopping season.

Let's take a closer look.

Sales trends were bad

Sales trends improved from the first quarter's 34% revenue decline, which was driven by COVID-19 store closures. GameStop's digital division was the standout again in Q2, with gains jumping to 800% compared to 500% in the first quarter.

A young man wearing a headset and holding a console controller

Image source: Getty Images.

Still, its overall growth trends are far from positive. Sales fell 27%, or a bit more than the 22% slump investors were expecting. The key factors hurting the top line included lower demand for software and hardware products, reduced customer traffic thanks to the pandemic, a shrinking store base, and a continued shift toward direct digital game spending.

Financial wins

GameStop managed to notch important wins despite that brutal selling environment. It permanently closed many of its worst-performing stores, slashed costs, and moved more spending to its online channel. These trends combined to boost efficiency, leading to improved cash flow. GameStop counts over $700 million of cash on the books today, which is well above its current market capitalization.

But the chain's adjusted net losses still nearly doubled, rising to $85 million compared to $46 million a year ago. Its other financial metrics were similarly weak. Gross profit margin shrank to 27% of sales from 31%, mainly because its sales base tilted even further toward hardware products and away from its more profitable software and collectables sales.

Looking for a reset

CEO George Sherman and his team highlighted the chain's flexible and efficient posture heading into the holiday season and the next generation of gaming consoles. The good news is GameStop has dramatically reduced its inventory while transitioning into an effective multichannel retailer. "We believe we are ready," Sherman said, "to handle the expected surge in demand and participate in a very significant way in the console launches later this year."

GameStop's sales bounced back after the last generation switchover about seven years ago. But its grip on the industry is weaker this time around, especially with the buy-sell-trade model fading in popularity.

That challenge -- plus major risks around the economic environment, further outbreaks, and persistent customer traffic pressures at its stores -- should have investors feeling extra cautious about buying this stock. Yes, it's clear that GameStop can easily improve its finances and isn't in any immediate liquidity danger.

But the retailer is also heading into this next generation of consoles armed with a questionable set of competitive advantages. That's why, if you're looking for exposure to this industry, the attractive bets are with publishers like Activision Blizzard, whose growth and margin-boosting opportunities are expanding rather than shrinking.

Demitri Kalogeropoulos owns shares of Activision Blizzard. The Motley Fool owns shares of and recommends Activision Blizzard and recommends the following options: long January 2022 $75 calls on Activision Blizzard and short January 2022 $75 puts on Activision Blizzard. The Motley Fool has a disclosure policy.

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