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Will GameStop Investors Get Crushed This Week?

By Demitri Kalogeropoulos - Mar 22, 2014 at 2:00PM

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The video game retailer is set to make two announcements on Thursday that could send shares soaring -- or tanking.

This is a big week for GameStop ( GME -2.57% ) shareholders. On Thursday, the retailer will post earnings results for its fourth quarter before hosting an investor conference later that day. Through those announcements, we'll get a much clearer picture on how GameStop is reaping the rewards of the industry's return to growth. But the world's biggest video game seller will also need an answer for developing risks to its business, including the rising popularity of digital downloads.

A generational thing
The bad news for shareholders is that the next-gen console rollout hasn't been a big win for GameStop so far. Sure, new devices from Microsoft ( MSFT 2.23% ) and Sony ( SONY 0.55% ) sent gamers flocking to its stores: Comparable sales spiked higher by 10% over the holidays as hardware revenue (i.e., Xboxes and PlayStations) doubled 2012's result. 

But all of that extra hardware revenue came at a steep price. GameStop's sales of new games for the prior generation of consoles dove lower by 22%. And pre-owned game sales only rose by 7%. In other words, gamers spent most of their cash on new consoles over the holidays, which netted GameStop less in profitability than would normally be the case.

Thanks to that unfortunate trend, Wall Street expects the company to book a respectable 6% quarterly sales improvement on Thursday, to $3.8 billion — but a brutal 10% drop in profits to $1.93 a share. And that per-share profit dip is despite GameStop having hacked away at its outstanding share count: The share base is about 6% lower now than it was a year ago, including the 800,000 share buyback it completed during the holiday season. 

Digital threats
Still, GameStop's profitability pinch is a short-term issue that should clear up as a used game market develops for the Xbox One and PS4 consoles. One threat that won't get better with time, though, is the move toward digital game downloads.

Both Activision Blizzard (NASDAQ: ATVI) and Electronic Arts ( EA -0.14% ) reported a continued spike in online content sales last quarter. That channel has now grown to more than 33% of each game publisher's total sales base, which is reason to worry. GameStop's answer so far has been to diversify its business and to invest in its own digital products. And while those strategies are helping, investors will want to know how management plans to transition into the all digital world that's coming over the next decade or so.

Looking ahead
For the near future though, GameStop doesn't have too much to worry about. The next-generation console launch is tracking well ahead of the prior generation's numbers. And the retailer's profits should really start rolling in as software revenue bounces back to its historical level as a percentage of sales. Meanwhile, cash flow continues to be strong, which allowed GameStop to boost its dividend by 20% earlier this month.

Heading into Thursday's announcements, shares are down a full 33% from the all-time high set in November. They now yield well over 3% on a valuation of just 13 times this year's temporarily depressed earnings, compared to the broader market's P/E of 16. GameStop's future isn't all rosy, but it isn't that bleak either, in this Fool's opinion.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
$191.18 (-2.57%) $-5.04
Microsoft Corporation Stock Quote
Microsoft Corporation
$337.97 (2.23%) $7.38
Electronic Arts Inc. Stock Quote
Electronic Arts Inc.
$124.04 (-0.14%) $0.18
Sony Corporation Stock Quote
Sony Corporation
$122.52 (0.55%) $0.67

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