GameStop's (GME 7.58%) outlook is finally improving. The video game retailer has been shrinking for years thanks to the combination of a poor selling environment and several strategic blunders. COVID-19 retailing shutdowns amplified this slump in early 2020, and so did the switchover to a new generation of video game console hardware.
Its latest earnings report, released Dec. 8, points to an end to that brutal operating period. But the chain still has a long way to go before investors can be confident about its growth strategy.
Let's take a closer look.
Image source: Getty Images.
Hitting an easy target
GameStop's third-quarter sales landed in the ballpark of management's goals, executives said in the quarterly filing. But growth was still awful. Revenue fell 25% year over year at existing locations to mark a slowdown as compared to the prior quarter when comps declined 13%.
Management tried to put a positive spin on the result by noting solid growth in the e-commerce division. GameStop was also operating under historic stress brought on by the twin challenges of COVID-19 and a new console switchover. "Our third quarter results," CEO George Sherman said, "reflected operating during the last few months of a seven-year console cycle and a global pandemic."
Making those cuts
GameStop made progress in reducing its financial exposure to better match up with today's retailing video game demand. The store base shrank by 11% and inventory plunged by 33%.
Combine those moves with management's aggressive pace of debt retirement and there's hope that the business will be on sounder financial footing soon. Yes, net losses were still significant. But they improved year over year.
GameStop also ended the quarter with $446 million in cash, up from $290 million a year ago. The chain is preparing to bolster those holdings by issuing more stock. CFO Jim Bell said the move would give management more flexibility as they pursue their transformation strategy.
Looking ahead
The good news is that sales got an immediate lift once new console releases from Sony and Microsoft became available last month. GameStop said it is seeing "unprecedented demand" for new hardware and software at the start of Q4. "[F]or the first time in many quarters," Sherman explained, "the fourth quarter will include positive year-on-year sales growth and profitability."
Each of these metrics has been negative for most of the last two years, and so the rebound will be welcomed by shareholders.
GME Operating Revenue (Quarterly YoY Growth) data by YCharts.
But investors shouldn't read too much into a single quarter of positive operating metrics. GameStop hasn't demonstrated that it can stay relevant during this next console cycle at a time when video game publishers count nearly all of their revenue from digital sales. And even if the chain does reach sustainable profitability and sales growth, its annual base will be far smaller than the $10 billion record it set back in 2015. Its earnings potential might never fully recover.
All those risks should have investors feeling as cautious as ever about buying GameStop stock today. The company looks like it will survive a brutal operating environment in 2020. But the harder levels are still ahead.
