On Wednesday, GameStop (GME -4.09%) released its latest earnings report. Unsurprisingly, the company continued to struggle mightily in its third fiscal quarter. While sales rebounded from a big pandemic-induced drop in 2020, GameStop's losses widened even further.
Management continues to insist that its turnaround strategy will drive meaningful long-term revenue growth and that profits will naturally follow. However, with each passing quarter, it becomes increasingly clear that GameStop has no credible path back to profitability.
Revenue recovers somewhat
GameStop posted net sales of $1.3 billion last quarter: up 29% year over year. This result wasn't nearly as impressive as it might appear, though.
First, GameStop's third-quarter revenue exceeded $1.4 billion in 2019 and exceeded $1.9 billion a year before that. In short, the gaming-focused retailer hasn't really returned to growth. It just recovered some of the previous year's revenue decline. For comparison, Best Buy (BBY -0.63%) recorded $11.9 billion of revenue last quarter: up 22% from two years earlier.
Second, the launch of new PlayStation and Xbox gaming consoles in late 2020 is driving a short-term sales lift for gaming hardware. Between August and October -- the period that corresponds to GameStop's third fiscal quarter -- U.S. gaming hardware sales surged 59% year over year, according to NPD.
Likewise, GameStop's hardware and accessories sales jumped 62% last quarter, accounting for nearly all of the company's top-line growth. By contrast, software sales slipped 2% on top of a 39% plunge a year earlier.
The margin crunch continues
While any kind of revenue growth is better than no revenue growth, gaming hardware tends to sell at very low margins. Historically, software sales have accounted for the bulk of GameStop's gross profit.
Thus, the dramatic mix shift toward hardware is driving gross margin lower. GameStop reported gross margin of 24.6% last quarter, down from 27.5% a year earlier (and 30.7% the year before that). As a result, gross profit rose just 15% year over year, well shy of the company's 29% revenue growth.
Meanwhile, GameStop's operating expenses rose 17% year over year. That caused its operating loss to widen to $103 million last quarter, up from $84 million in the prior-year period, excluding asset sale gains. GameStop posted a Q3 net loss of $1.39 per share: far worse than the $0.52 loss per share that analysts had expected.
There's no "there" there
To be sure, CEO Matt Furlong claims that GameStop's massive losses are just part of a long-term strategy. During the company's recent earnings call -- which lasted less than 10 minutes -- he said, "We believe revenue growth will translate to scale and market leadership. And from there, scale and market leadership will translate to greater free cash flows over time. Our focus on the long term means we will continuously prioritize growth and market leadership over short-term margins."
However, revenue growth does not automatically translate to scale and market leadership. Management's quixotic strategy to grow revenue at all costs will just aggravate GameStop's losses.
In particular, GameStop's moves to expand its assortment with consumer electronics products like TVs might drive some top-line growth, but at the expense of profits. GameStop will never have scale or market leadership in the general consumer electronics business. For example, Best Buy is set to generate over $50 billion of revenue this year, compared to less than $6 billion for GameStop.
In a best-case scenario, GameStop will eventually end up like a smaller, less profitable version of Best Buy. More likely, it will never find a sustainable business model and will continue losing money and burning cash indefinitely. Given that you can invest in Best Buy -- which is highly profitable -- at a $25 billion valuation, owning shares in money-losing GameStop at a $12 billion valuation doesn't make sense.