Last week, video game retailer Electronics Boutique (NASDAQ:ELBO) posted strong sales and earnings growth for its 2004 fiscal year. However, there may be a time bomb hidden in those impressive numbers.
Revenues grew 21%, comprised of 17% growth in hardware sales and 33% growth in video game software sales. Profits rose 26.8% to $1.80 per share before the effects of an accounting change, but including the effects of a services agreement termination. Yet, even if you took out the positive effect and included the negative accounting change effect, earnings would have increased by more than 5%.
Most of the company's sales growth came from opening new stores. While comparable-store sales were flat for the year, and rose only a modest 2% for Q4, the company increased its store count one-third to 1,528.
I find that torrid rate of growth worrisome. When a company increases its store count by 33% but grows revenues at less than two-thirds that rate and earnings at just a bit more, you have to wonder whether the growth is really worth the effort -- and what will happen when the company has nowhere left to grow.
Faithful readers of Motley Fool Select, now Hidden Gems, may recall a similar story of hyper-growth followed by a hyper-decline in profits: Lone Star Steakhouse (NASDAQ:STAR). That chain, too, grew rapidly in both store count and revenue, only to hit a wall in 1998. Back then, Lone Star was expanding strongly in Australia. Coincidentally, Electronics Boutique says that in 2004 it "strengthened its leadership position in Australia." Not that I consider doing business in Australia to be the mark of Cain for a business, mind you -- I just find the coincidence unsettling.
Assuming Electronics Boutique hits the high range of its earnings guidance for 2005, it will post only an 8% increase in profits over 2004. That, despite a promise to open another 400 stores in fiscal year 2005.
I repeat: They will have 26% more stores than they currently have, but earn only 8% more profits than they just finished earning.
Tick, tick, tick.
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Rich Smith owns no shares in any company mentioned in this article, but he is sure that his little brother -- a devoted gamer -- accounted for roughly half of Electronics Boutique's sales growth in fiscal 2004. The Fool has a disclosure policy .
