Things aren't as awful as many GameStop (NYSE:GME) investors feared. The video game retailer last night announced strong holiday sales results that point to healthy profit growth ahead. The stock, which is well off the $46 high set in July, jumped 10% to $36 immediately following the announcement.
The results certainly don't look impressive at a glance. GameStop's revenue fell 4% from the 2013 holiday season. Comparable-store sales were also down 3% through that critical period for the retailer. However, a closer look at the numbers shows why Wall Street is celebrating this announcement.
Why shares are up
The main reason for GameStop's holiday sales declines was the huge drop in new hardware sales. That single product line tanked by 30%, or by more than $300 million of revenue. But that's OK, given that the 2013 results included the November launch of next-generation consoles from Microsoft and Sony. This year's sales just couldn't compare with those figures.
Strip out that hardware launch, though, and it's clear that GameStop is still selling plenty of Xbox One and PlayStation 4 devices -- and that the rest of the business is holding up well. The company said it moved 30% more units of next-generation hardware this past December. It also booked a 9% improvement in new software sales and a 1% gain in the pre-owned games business.
CEO Paul Raines highlighted that 9% software gain, which included a doubling of next-gen video game sales, as particularly encouraging. In a press release accompanying the results, he said: "During the holiday period, consumer demand for video games was strong, resulting in new software sales growth. We expect that trend to continue into the first quarter."
Profit gains ahead
Profitability gains will be another benefit of the relative drop in hardware sales and improvement in software sales. New hardware carries the lowest profit margin of any product GameStop sells, clocking in at just 11% in the last quarter. New video games are twice as profitable, while pre-owned games carry a whopping 48% profit margin. GameStop's shifting sales profile points to a substantially higher overall profit margin when it posts its full fourth-quarter earnings results.
Meanwhile, the company continues to succeed in the digital world, booking a 46% gain in revenue tied to business segments including downloadable games and season passes. Far from killing the retailer, digital sales are boosting its results, just as they are for video game publishers right now.
Management took the opportunity last night to affirm its overall targets for the fourth quarter. Those call for a slight drop in comparable-store sales, and for earnings to grow by 14% to $2.16 per share. That result would leave the stock valued, even with today's jump, at what I consider a fairly cheap 10 times 2014's expected earnings of about $3.50 per share.
Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.