Are the 'Shorts' Still in Fashion?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
GameStop (NYSE: GME) has been a famous stock that short sellers love to hate. The theory is, the company will eventually disappear as gamers move toward more digital sales and rely less on physical discs. As recently as February, GameStop was the number one most shorted stock in the S&P 500 based on the percentage of shares sold short. Since then the stock is down about 16%, so the shorts have something to brag about. That being said, there are developments on the horizon that short-sellers need to be keenly aware of. Let me show you what I found, when I read through the company's most recent quarterly earnings.
The company reported that total sales were down 12.2%, comparable sales were down 12.5%, and EPS was down 3.57%. One positive is at current prices the company's dividend yield is over 3%. Even with these disappointing results, I'm sure there are less people willing to short GameStop at this point. Covering a 3% dividend and given the shares are already down 16%, there is less potential for profit than there was just a few months ago. The company is also doing what it can to prop up the price by repurchasing 5.35 million shares in the first quarter alone. The company's average price was $22.70 per share, so buying today you are getting a discount to what the company was willing to pay.
Something that stood out in GameStop's financial statements was the line item for gross margin. Though sales were down, gross margin improved from 27% to nearly 30%. A big part of this margin improvement had to do with the company's mix of sales which we'll look at in a minute. The other big factor that affected EPS, was the company retired 6.19% of their outstanding shares in the last year. Last but not least, the company has no long-term debt as compared to $249 million in debt last year.
The company gets about 54% of sales from new video game hardware and software. In this way, GameStop is a good proxy for whether there are new titles and systems being introduced. In the first quarter there were no significant systems or titles, which lead to the sales decline. With GameStop's established trade-in capabilities, the company is able to buy older games cheap, and then resell them at a profit. This well known business generates about 31% of sales. The smallest part of sales right now comes from a category the company calls “Other.” This 15.2% of sales should be renamed something like “Digital and Mobile Sales” because that's what is represents. Most people who bet against GameStop assume the company is not in the digital or mobile arena and that is just not the case.
Where things get really interesting is how the split of sales falls to the bottom line in profits. Even though over half of sales are from new hardware and software, the profits from this segment only accounted for 10.4% of total income for the most recent quarter. The company made the lions share of its profits from used video games and “Other.” Used Video games represented 49.1% of profits and “Other” accounted for over 40% of profits. Sales of digital and mobile (Other) grew by 23%, and as this percentage of sales gets larger, this should lead to better overall profits for the company.
I'm less concerned with the company's second quarter guidance, and more interested in where GameStop believes it will end the year. The company reaffirmed that they believe EPS will come in at $3.10 to $3.30 compared to analysts estimates of $3.16. The company also made a point to say that “current guidance only includes the effect of the shares repurchased thus far in 2012.” This is an important distinction because with $455 million still available under the company's current share repurchase plan, more share buybacks would increase guidance even further.
I've heard it said that future games will be all digital and physical media will go away. That might be true at some point, but as for the near future, not so much. Both Sony (NYSE: SNE) and Microsoft (NASDAQ: MSFT) were looking at eliminating the disc drive, but a big concern was the availability of decent Internet connection speeds worldwide. The companies worried that gamers might not buy the platform because it would take hours to download just one game. The next generation of Xbox isn't planned until probably Christmas 2013 at the earliest, but Sony seems to have other plans for the next generation PlayStation. Orbis (the codename for the next system) is actually rumored to be released late in 2012. Granted these are rumors, but a new hardware system by the end of this year would be a win for both GameStop and Sony. It would give GameStop some new hardware and new titles to push sales, and it would give Sony a first-mover advantage in the console wars. When it comes to software, there are titles being released currently that should help GameStop in the near future.
The first quarter was decidedly devoid of what the company called “AAA game releases.” However, the recent release of Diablo 3 by Activision Blizzard (NASDAQ: ATVI) sold 3.5 million copies in the first 24 hours. Senior VP of marketing at GameStop, Bob McKenzie said that, “Diablo III was one of our biggest PC launches ever and will help make this a record year for Blizzard at GameStop.” This would seem to argue for a stronger showing in the second quarter. The remainder of 2012 looks to be a decent year for new games as: Max Payne 3, The Amazing Spider Man, NCAA Football 13, Madden 13, Transformers, Far Cry 3, Assasins Creed III, Call of Duty Black Ops II, and many others are all slated for this year.
Long story short, GameStop had a bad first quarter because there wasn't much for them to push. The company should have better results in the second quarter, and the third and fourth quarters should be the strongest of the year. With management still guiding that EPS already could beat expectations, any new hardware or share buybacks would just add to future earnings. The company's growth in digital sales is something I think shorts are overlooking and I wouldn't be betting against this retailer at this time.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard, GameStop, and Microsoft and is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend Activision Blizzard 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.If you have questions about this post or the Fool’s blog network, click here for information.