GameStop's (NYSE:GME) fate isn't any more upbeat than it was when it hit a new 52-week low last month, or when it posted disappointing quarterly results a month before that. The leading video-game retailer is in a funk, and it's not a real surprise.
The sale of video games on discs and cartridges continues to fall out of favor as digital delivery and other forms of entertainment gain in popularity. Wall Street's been coming to the conclusion that GameStop isn't worth as much as it had initially hoped, and during the past few days, we've seen plenty of Wall Street pros whittle away at their price objectives.
- Credit Suisse is sticking with its neutral rating, lowering its price target on Wednesday from $44 to $42.
- Earlier this month, we saw Oppenheimer stick with a bullish rating as it cut its price target from $47 to $40. It was as high as $60 last February.
- If we go back to late November, a still bullish Bank of America Merrill Lynch slashed its goal from $56 to $52.
Naturally, it's not good when several analysts are hosing down their forecasts of where a company's stock will be a year from now. However, with GameStop shares dropping to the low $30s as 2015 gets underway, even the weakest of those price targets represents a healthy gain of 17% from current levels.
Analysts may have soured on their expectations, but the stock has taken an even harder hit. The disparity could lead some opportunistic investors to nibble at GameStop here -- especially given its fat yield of nearly 4% -- but that would be a pretty big mistake.
Yes, GameStop is now fetching a forward earnings multiple in the single digits. GameStop is finding ways through stock buybacks and its compelling unit economics to squeeze out improving profits on a per-share basis. It's probably not sustainable.
Facing the end boss
Let's start with GameStop's most recent financial report, covering the fiscal third quarter that ended on Nov. 1. Comps actually slumped 2.3% despite a 148% surge in new hardware sales. Folks are snapping up plenty of Xbox One and PS4 consoles -- they didn't hit the market until just after the prior fiscal year's third quarter came to a close -- but this is also a low-margin category. With higher-margin software sales plunging 34%, there isn't a lot that a slight uptick in the even higher-margin pre-owned merchandise category can accomplish. The end result isn't pretty -- adjusted net income fell during the fiscal third quarter.
GameStop blamed the weak software sales on the delay of Assassin's Creed: Unity, but seeing that game's release shift to the retailer's fiscal fourth quarter didn't stop it from providing uninspiring guidance for the holiday period. In short, it was a hollowed-out scapegoat. The midpoint of its guidance at the time suggests another quarter of declining comps when GameStop reports again next month.
Wall Street still believes. Analysts see net sales and earnings moving higher in the new fiscal year that begins next month. It's hard to find the catalysts that will make that happen. Console makers continue to push their own digital platforms. GameStop's own digital initiatives at one time seemed promising, but they're not exactly moving the needle at less than 10% of its total revenue.
GameStop isn't going away. It has a healthy balance sheet, and paying cheap rent in small strip mall locations will keep it profitable. However, as the digital migration continues -- and gamers find themselves with fewer reasons to hit up the local GameStop -- will this be a sustainable model? The fat dividend checks may continue even as the fundamentals start to crack; but eventually, investors will have to ask themselves what purpose GameStop will serve as a concept in five to seven years from now.
The low P/E and high yield look great now, but the next few levels that GameStop will be playing have wrecked plenty of fading retailers.