This Retailer is Set to Soar, Ramp Up Your Portfolio

Palwasha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Stocks of brick-and-mortar stores, such as Best Buy and RadioShack, are constantly being criticized by analysts around the web. Rightly so, considering that we’ve seen these stores losing their market share and turning around less-than satisfactory earnings in the last few quarters. Shifting trends, including the rise of e-commerce, the convenience of buying online, cloud-based services, greater ease and availability of downloadable digital content and online behemoths like Amazon (NASDAQ: AMZN) offering cheaper deals, have all rendered these stores unprofitable. One new addition to the list of these struggling stores is GameStop (NYSE: GME).

GameStop, however, receives mixed sentiments.  As some analysts remain bearish on the stock, Wall Street suddenly seems to be showing interest in the video games retailer. Goldman Sachs presently gives it a buy rating and sets a $25 price target. Bear in mind that Wall Street likes to play it for the short run, but investors like you and me like to gauge a company for its long term prospects. The latest short term optimism for the stock comes primarily from the impending launch of Nintendo’s (NASDAQOTH: NTDOY.PK) new gaming console, the Wii U, which is due on shelves next month.

With Nintendo’s final announcement of Wii U’s pricing and availability particulars, GameStop and other retailers, including Best Buy and Wal-Mart, have moved in to take advantage of pre-orders. Good news for these physical stores is that their online competitor, Amazon, got left behind in the race; Amazon hasn’t been able to make the new console available on its online store yet, while physical retailers got fully sold out on pre-orders.

GameStop Set to Make a Comeback

Both this year and the next look bright for GameStop. Sony’s (NYSE: SNE) new PlayStation (codenamed Orbis) and Microsoft’s (NASDAQ: MSFT) new Xbox (simply called the Xbox 720) are both likely to be released by the beginning of the holiday season in 2013. By the time GameStop has made money on Wii U and its new games, it’ll be moving on to selling another series of consoles and games.

Historically, upon comparing the prior consoles’ releases with the stock’s price movement, we can see a pattern. Gamestop’s stock jumped to as high as $50 (and higher) after the three competing consoles were released back to back. GameStop let gamers walk in to its stores and try out the console and the game they wanted before they made a decision to purchase it.

The next two years, following the release of the three consoles, also played out really well for GameStop. Even if sales of new consoles were gradually heading for a decline, the demand for used consoles, accessories, and games was on the rise. The three year period from the end of 2005 to 2008 has historically been the best for the stock. We can expect to see history repeating itself once again.

<table> <tbody> <tr> <td> </td> <td> <p>Released</p> </td> </tr> <tr> <td> <p><strong>Xbox 360</strong></p> </td> <td> <p>Nov '05</p> </td> </tr> <tr> <td> <p><strong>PS3</strong></p> </td> <td> <p>Nov '06</p> </td> </tr> <tr> <td> <p><strong>Nintendo Wii</strong></p> </td> <td> <p>Nov ‘06</p> </td> </tr> <tr> <td> <p><strong>Xbox 360 Arcade</strong></p> </td> <td> <p>Oct '07</p> </td> </tr> <tr> <td> <p><strong>PS3 Slim</strong></p> </td> <td> <p>Sep '09</p> </td> </tr> <tr> <td> <p><strong>Xbox 360 250GB</strong></p> </td> <td> <p>Jun' 10</p> </td> </tr> <tr> <td> <p><strong>Kinect</strong></p> </td> <td> <p>Nov '10</p> </td> </tr> </tbody> </table>

<img src="/media/images/user_13250/picture1_7_large.png" />

Speed Bumps or Road Blockers?

Smartphone gaming apps and social media games have deeply hurt companies that relied solely on console video gaming. These include game publishers like Electronic Arts and Activision Blizzard, console vendors like Sony and Nintendo, and even retailers like GameStop. However, one aspect of GameStop’s business that keeps it alive, despite declining video games and consoles sales, is its move towards becoming  an ‘electronics retailer’, and not just a ‘video game retailer.’ As CEO Paul Raines rightly puts it, "In order to survive, our internal rate of change has to be greater than the external rate of change."

To remain competitive, GameStop has increased its offering of used smartphones including iPhones, used tablets, and PC software. And this is why this segment of GameStop was the only one that saw an increase in revenues by as much as 40% in the latest quarter, although the videogames-specific segment saw a decline.

The consumer market is slowly adopting digital content over physical one. Some fear that GameStop, which makes a big chunk of its profits out of sale of used physical discs, may suffer badly once the transition to the digital medium is complete. To cope up with this, we saw GameStop acquire Impulse last year. Impulse is a digital PC games distributor that competes with Steam (privately held). Steam holds more than half the market share of digital PC games and is a gigantic competitor in the digital gaming arena.

GameStop still has a long way to go, but so does the switch to digital content. It is important to note here that console vendors come out with limited data storage capacity in their first versions. Gamers will recall how Xbox took 5 years to go from the 6GB version to the 250GB and now the 350GB version. Likewise, PS3 initially came out with limited storage and later expanded to higher GBs. Nintendo’s new Wii U is again being released with a limited capacity for storing digital content.

It will take another 1-3 years before bigger-capacity consoles start appearing on shelves. That will leave gamers with a limited choice to use digital content. So, with the launch of new consoles, the demand for physical content is going nowhere but up. You can safely expect the retailer’s sales to go north in the next two years.

Bottom Line

The concerns I’ve discussed look more like speed bumps than road blocks. GameStop still has a lot of room to run, and it will likely find a way around these obstacles. Online retailers like Amazon may pose a threat, but they ultimately don't offer what GameStop does--the opportunity for gamers to try out new stuff before purchasing it and immediate compensation if they want to sell their used stuff.

The company just started returning value to shareholders in the form of dividends and its fundamentals look great too. GameStop has 0 debt/equity, 4% dividend yield, highest profit margins, lowest beta (market risk), highest returns to equity and assets (ROE & ROA), compared to competitors Best Buy and RadioShack, with whom it is often compared. Releases of new consoles will prove a boon to the retailer for at least the next 2-3 years. Consider its current price as an entry point for a long position in the stock. Invest wisely!

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PalwashaS has no positions in the stocks mentioned above. The Motley Fool owns shares of, Best Buy, GameStop, Microsoft, and RadioShack and is short RadioShack and Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend 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.

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