Grapevine, Texas-based GameStop (GME 2.84%), the world's largest video game retailer, has enjoyed a large share price appreciation year-to-date. However, after GameStop released a strong quarterly earnings report but downbeat holiday- season guidance on Nov. 21, the company's shares took a hit.
Is this drop indicative of future pain for GameStop, or is this dip opening up a buying opportunity? I believe that while GameStop's stock price appreciation might finally be catching up to GameStop, the company still has room to grow if it continues to adapt to the challenging video game industry amid some key catalysts from the likes of Sony (SNE 1.79%), Microsoft (MSFT 1.84%), Take-Two Interactive (TTWO 0.59%), and Nintendo (NTDOY 3.54%).
Strong earnings propelled by strong products
GameStop's business model is heavily dependent on other video game companies churning out products that gamers consistently want to buy. As long as there are strong video game companies, supposedly GameStop will have good inventory with which to stock its shelves. This fact has helped propel GameStop's stock over the last year and is reflected in the last earnings report.
A key catalyst for GameStop's huge third quarter was a 43.1% increase in new software sales, driven mainly by high demand for Take-Two Interactive's Grand Theft Auto V.
Overall GameStop sales rose by 19% to $2.1 billion, while earnings came to $0.58 per share -- a 45% increase from the same period a year ago. Analysts had forecast a profit of $0.57 per share on sales of nearly $2.0 billion. GameStop also posted a robust 20.5% jump in comparable-store sales, which was a good deal above GameStop's own forecast of 11% to 15%.
With new highly anticipated console launches from Sony (ADR) and Microsoft as well as Nintendo's much-awaited title The Legend of Zelda: A Link Between Worlds, GameStop should benefit. Sony's Playstation 4 and Microsoft's Xbox One are shaping up to be the titans of the holiday console wars. Household name Nintendo should benefit from sales of the 3DS and 2DS platforms and games despite disappointing lagging sales of the Wii U.
GameStop is the focal point of much of the video game industry action, so whichever way the tides turn GameStop is arguably poised to profit. Gamers will shop at GameStop to buy whatever games are striking their fancy.
So why the weak forward guidance?
With all of the strengths GameStop exhibited in the last quarter and several prior quarters, why are there new-found fears about the holiday season? GameStop is predicting that its earnings per share will be in the $1.97 to $2.14 range for the holiday quarter, compared to Wall Street estimates calling for earnings of $2.15 per share.
Low guidance is indicative of GameStop's management gauging the console industry's struggles adapting to mobile and online gaming. This is a long-term problem for GameStop as mega launches of new consoles like the PS4 and the Xbox One and games like A Link Between Worlds should make GameStop's management optimistic for the holidays.
The holiday season is when a large chunk of retailers' annual income is hauled in. Any weakness during the holiday season is generally seen as a big negative sign for a business. GameStop's major weakness is that its business model is based mainly on the physical console market. If the shift to mobile and online gaming continues to disrupt the traditional gaming kings, GameStop will be in troubled waters.
The bottom line
GameStop's business model, while fragile, is comparably stronger than other gaming companies and has consistently generated good returns for shareholders over the past year. GameStop's relatively high dividend is another key factor that should attract dividend investors.
Unlike companies like Take-Two Interactive Software, GameStop is a more diversified bet on the video game market and will profit regardless of who wins the battle between Sony and Microsoft. Nintendo's 3DS and 2DS success has been somewhat offset by floundering Wii U sales, so Nintendo appears to be riskier.
However, much of GameStop's success has been already accounted for in its current stock price, so new investors might be deterred. If you currently own GameStop shares, I would suggest holding on for now to see how the market gauges the company moving forward.
