GameStop (GME) is not worth the risk.
Despite the promises of a strategic turnaround plan, I just don't see the upside with GameStop. The company is simply in the wrong place at the wrong time: There isn't any real barrier to entry on GameStop's business, and big-time retailers like Walmart (WMT) and Amazon (AMZN) don't have to work very hard to offer the kinds of gaming equipment that GameStop depends on.
And now the video game retailer has reported abysmal second-quarter results, with big declines in sales and profits. Because of the extremely low valuation of the shares, there has been some chatter about the potential upswing if the company could find a good quarter. While there is certainly always the possibility of a surprise bounce, I think there's too much risk with GameStop.
As part of its turnaround plan, the company has focused on building a stronger digital presence, but the current financial fallout makes me worry about what state the business could be in by the time that happens.
Financials: Off Target
Total sales decreased 14.3% to just under $1.3 billion. On a comparable basis, same-store sales decreased 11.6% year-over-year. The makeup of these sales declines was pretty much across the board. New hardware sales fell by a haunting 41.1%; though the company noted that the upcoming round of new consoles scheduled for 2020 tends to cause this type of trend. New software sales fell 5.3%, slightly offset by strength in Nintendo Switch titles. Sales of accessories fell 9.5%, pre-owned sales of used equipment -- including both software and hardware --dropped by 17.5%, and digital receipts fell 11.2%, thanks in part to poor title launches. That brought digital receipt revenues to $227.2 million.
The lone bright spot for GameStop was collectibles. Sales of collectibles increased by 21.2%, with strength both domestically and internationally. In all, the $171.8 million in collectibles revenue represented 13.4% of the company's total sales mix during the quarter.
It will come as no surprise that these sales declines resulted in some pretty significant losses during the second quarter. On an unadjusted basis, which includes asset impairment charges of $400.9 million, GameStop reported a net loss of $415.3 million, or $4.15 per diluted share. On an adjusted basis, GameStop reported losses of $32 million. That breaks down to a loss of 32 cents per diluted share. That's more than triple the $10.2 million loss reported last year.
Looking ahead to the full year, GameStop is expecting comp sales declines to be in the low teens, while adjusted earnings per share are expected to be $1.15 to $1.30 per diluted share. One has to wonder how bad this might get, especially on a generally accepted accounting principles -- or GAAP -- basis.
The company noted that by implementing its cost-saving and operating profit initiatives, it now expects improvements in annualized operating profit in excess of $200 million as opposed to the previous guidance of $100 million. For reference, GameStop has $429 million in operating losses in the first 26 weeks of 2019.
While cost cutting an operation can certainly be positive, there's not a ton here that indicates a clear path for GameStop to fix its sales woes. It can cut the parts of its brick-and-mortar business that are weighing it down, but based on the declines, that seems like a lot. As for the company's intent to become "the social/cultural hub for gaming," I'd say there's a pretty big order at this point.
The release of new game consoles next year definitely has the potential to give places like GameStop a nice boost in sales, but also gives that same potential to places like Walmart. With the shifting landscape of gaming, I don't like the risk of owning a retailer that is wholly dependent on such a specialized market, especially when large diversified retailers can also participate in that market.
The Books Are Suffering
The balance sheet is taking some pretty meaningful hits right now. While cash is up to nearly $425 million, total shareholder equity has declined rapidly. Total equity is now a little under $810 million vs. $2.1 billion a year ago. From an ultra value perspective, GME stock is trading well below book value with a market capitalization of $521 million. Depending on where aftermarket trading takes us on Wednesday morning, that figure could be even lower. While it might be tempting to have a stake in a balance sheet worth far more than the stock, one needs to consider what the next few quarters might do to that balance sheet.
I just plain old don't like the risk here. You have a company in an evolving industry, with massive exposure to the pitfalls of over expanded brick and mortar, and a turnaround plan that seems likely to take quite some time to be meaningful. In the mean time, the balance sheet is probably going to suffer further. I don't see the point of playing around with it unless you want to play a high risk game.
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