Don't Count This Company Out Yet

By Chad Henage - August 29, 2012 | Tickers: AMZN, BBY, GME, WMT | 0 Comments

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It seems too simple to assume that a company that primarily sells video game hardware and software will disappear as more consumers choose digital sales. However, there is a transition happening at GameStop (NYSE: GME) that many people seem to be ignoring. In addition, it's a bit unfair to look at a company's results when one of their primary businesses is producing next to nothing important to sell. Let's take a look at GameStop's recent earnings and I'll show you what I mean.

GameStop is in the unenviable position that their primary business is hurting while waiting for new titles and new hardware to boost sales. In addition, companies such as Best Buy (NYSE: BBY), Walmart (NYSE: WMT), and Amazon.com (NASDAQ: AMZN) are all moving in on the company's traditional business. While most people are aware of Best Buy's challenges, the company still operates nearly 1,000 big box stores and most of the stores have a large section dedicated to the most popular game hardware and software. Best Buy has recently expanded its used game selection to compete with GameStop directly. Walmart also sells popular hardware and software titles, but has yet to really get into the used game business. Amazon on the other hand, competes with all of the above by selling new and used hardware as well as new and used software titles. This competition has led some to believe the company is going the way of Circuit City. Even though the company's recent earnings were certainly not impressive, the strongest half of the year is coming up. Investors should know that there are changes going on behind the scenes that should benefit shareholders in the future.

In the company's earnings release, the headline numbers were enough to scare most people away. Sales decreased 11.1%, comparable sales decreased 9.3%, and diluted EPS came in at just $0.16 per share. What was interesting is among all these negative numbers, the company increased its dividend by 67%. There are at least two different things that I noticed in the financials of the company that many people seem to be overlooking. GameStop is well known for their used games, and most people assume that this is the primary driver of the company's fortunes going forward. However, the company's revenue and earnings are affected by multiple categories including new hardware and new software. Take a look at the split of the company's sales versus net income and you'll see what I mean:

As you can see, while it's true that used games are an important part of the overall picture, digital sales and new hardware and software represent a larger portion of both revenues and net income. With over 42% of revenues, and over 31% of net income affected by new hardware and software, it's not hard to understand why GameStop has been struggling. There hasn't been significant new hardware on the market for several years, and many of the new software titles are slated to come out later this year. What the company really needs is several good new titles to drive buyers into the stores. The company is also making a move into new areas and it seems this is been underreported.

While it's true the majority of the company's sales come from their over 6,600 stores, the company also operates a digital game distribution site, a streaming technology company, and an online gameplay site. As we saw above, these “other” divisions are beginning to be a significant contributor to the company's top and bottom lines. Specifically, the company saw digital receipts increase 27%, and the company's tablet and pre-owned iDevice sales were on track to reach $150 million to $200 million in sales. If the company is able to continue to grow its digital and other sales, GameStop could surprise some investors who expect the company to disappear. In the meantime, the company is doing everything it can financially to drive the share price.

As I mentioned before, the company significantly increased its dividend yield, and current prices yield 5.3%. In addition, GameStop repurchased 7.6 million shares at an average price of almost $18 during the current quarter. In the last year, the company has decreased its total share count by over 9%. Even with their clear size advantage, Best Buy, Walmart, and Amazon all have gross margins between 24% and 26%. GameStop by contrast, sports a gross margin of over 33%. What this should tell investors is, the company has the capability to compete directly against these larger retailers if price becomes an issue. In addition, the company's over 5% yield could by itself become an attractive feature of holding the shares. Particularly when you consider that Walmart's yield is just 2.2%, Best Buy pays just over 3%, and Amazon pays no dividend at all. GameStop's guidance for the remainder of the year is primarily tied to the multiple new titles due out in the third and fourth quarters.

While the company does expect comparable sales to decrease this year, they maintained full-year EPS expectations of between $3.10 and $3.30. With significant new titles due out from popular franchises, the end of the year should be much better than the first two quarters. In the third quarter, a new Transformers game and a new Madden game are both being released. In the fourth quarter, the ever popular Call of Duty: Black Ops series releases its sequel. New titles are also expected from Halo and Assassins Creed. These are all top-of-the-line brands that consumers have been looking forward to. With new hardware expected in the next year, this could point to a longer-term positive trend for the company. While investors wait for these positive developments, they can sit back and collect the over 5% dividend.

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