Analysts aren't impressed with GameStop's (NYSE:GME) latest financial update. The video game retailer posted unimpressive results for the holiday quarter last Thursday, and Wall Street shrugged its shoulders.
Credit Suisse lowered its profit target for the new fiscal year. B. Riley downgraded the stock, lowering its price target from $64 to $44. Other firms stuck to their earlier calls, but that's not the kind of stuff that excited investors.
Everyone figured that this would be a bad quarter for GameStop's hardware sales. The folks rushing to snap up Xbox One and PS4 consoles during the 2013 holiday shopping season when the systems hit the market weren't going to turn out in the same numbers this time around. However, it has to be disappointing to see software sales climb just 6% from one holiday quarter to the other. The economy's improving, highly anticipated games were released, and the installed base of next-gen consoles has widened.
It wasn't enough. Total global sales still took a nearly 6% hit, and while half of that dip can be explained by currency fluctuations, we still had U.S. comps sliding 1.4% at a time when many traditional retailers were bouncing back.
It's easy to feel that GameStop is the mother of all values. It had been one of the better retailers when it comes to returning money to shareholders through cash distributions and stock repurchases. It has boosted its quarterly dividend four times since initiating the payouts three years ago, and the current 3.7% yield is pretty savory in this climate of low interest rates on fixed income investments.
It has also proven to have a voracious appetite when it comes to swallowing down its own shares. Profitability peaked at $408 million in fiscal year 2010, according to S&P Capital IQ data, but that only amounted to earnings of $2.56 a share on 154 million shares outstanding. Four years later we find net income clocking in at just $393 million, but that results in normalized diluted profit of $3.37 a share on a weighted average of 113.2 million shares.
GameStop's ambitious buybacks have created one of the slickest illusions that you will ever see in that net income may be lower than it was four years ago, but normalized diluted earnings have risen every single year on a per-share basis.
There are signs that the gig is up. GameStop's weighted average diluted share count declined by 5.2 million in fiscal year 2014, the smallest decrease since fiscal year 2009. That's just what happens when you're throwing money at payout hikes and acquisitions. GameStop used to be able to buy its way out of quarterly profit shortfalls, but it has now come up short of analyst profit targets in back-to-back quarters.
As the popularity of games on discs and cartridges give way to digital delivery -- and gamers establish direct relationships with software developers and console makers -- the GameStop model will be hard to justify beyond the low-margin niche of hardware that feeds into the new ecosystems. GameStop has made relevance in the digital age a priority, but that's something that only sounds great in theory. It's hard to fathom a scenario where GameStop is more popular in three to five years than it is now, especially as diehard gamers trade up to the new systems that feast on digital delivery of content.
GameStop continues to have a compelling model that can deliver healthy margins in its strip mall setting for the near term. It also has a reasonable balance sheet, even though long-term debt has ballooned to its highest level since fiscal year 2009. In short, GameStop isn't going away anytime soon. However, it will eventually be going away, and it's up to investors and gamers to decide how long they want to stick around until that becomes clear to the market.