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What Will Stop GameStop Corp. (GME)?

GameStop Corp. (NYSE:GME)Video game retailer GameStop Corp. (NYSE:GME) is down almost 20% over the past week. The big news driving the stock lower was that first-quarter net income fell 25% year-over-year. Yet, the company still managed to beat Wall Street expectations, posting EPS of $0.46 compared to analyst expectations of $0.40. GameStop Corp. (NYSE:GME) is still the largest U.S. video game and PC entertainment-software specialty retailer, with more than 6,500 stores worldwide.
Revenue for fiscal 2014 is expected to only be down 0.5% after a 7% fall in 2013. The key driver of the decline in revenue is slowing purchases of consoles and games as consumers await the release of next-generation devices. There are some concerns related to GameStop’s used-game business as new game consoles come to market, which could shift game revenue from retailers to manufacturers, significantly downsizing the used game market going forward. About 25% of GameStop Corp. (NYSE:GME)’s revenue is derived from pre-owned game sales.
However, GameStop is looking to hedge this decline with growth in its digital sales and mobile business. These initiatives include GameStop’s move to a mixed retailer of physical and digital gaming and electronics products. GameStop expects the North American market for digital mobile, social, console and PC games to grow from $7 billion in 2012 to $10 to $12 billion by 2015, a compound annual growth rate of 13% to 20%. This should be in part driven by the recent and upcoming hardware platform technology evolution from Nintendo, Sony Corporation (ADR) (NYSE:SNE) and Microsoft Corporation (NASDAQ:MSFT) over the next year or two.

Other notable brick-and-mortar retailers that are competing with GameStop Corp. (NYSE:GME) include RadioShack Corporation (NYSE:RSH) and Best Buy Co., Inc. (NYSE:BBY). RadioShack Corporation (NYSE:RSH) has been one of the hardest-hit retailers and is continuing to close under-performing stores to help hedge the demand deterioration it is seeing. The stock has garnered a lot of short interest as well, with 38% of its float short.

For 1Q, RadioShack posted a $0.35 loss on 5.7% lower same-store sales and 7% lower total sales. Going forward, the pressures still appear to be afoot, as the retailer ended its partnership with Target Corporation (NYSE:TGT) for providing mobile kiosks in its stores.

RadioShack Corporation (NYSE:RSH) is now looking to increase its exposure to the smartphone market, which will structurally pressure gross margins. However, the competition is rich there too, with Best Buy Co., Inc. (NYSE:BBY) breaking into the market. Best Buy has opened 525 Samsung Experience shops in its big-box stores nationwide and another 390 in its smaller Best Buy Mobile stores.

Best Buy posted EPS of $0.32 compared to $0.76 for the same period last year; this beat consensus forecasts of $0.26. The earnings beat has in part lifted Best Buy’s stock of late, yet, a bigger problem is contracting margins; gross margin contracted 60 basis points to 22.6% last quarter year-over-year, and operating margin was down 170 basis points to 5.5%.

Compared to GameStop Corp. (NYSE:GME), Best Buy Co., Inc. (NYSE:BBY) is on a tear year-to-date.

Best Buy has seen a nice rebound; yet, I would argue that Best Buy should not outperform GameStop Corp. (NYSE:GME), and both should not be trading so closely on a long-term horizon. Over the past five years, both are down between 35% and 40%.

The numbers game

So why should GameStop outperform Best Buy? Well, for one, GameStop pays a dividend yield that’s 100 basis points higher than that of Best Buy:

GameStop Best Buy
Dividend yield 3.5% 2.5%
From both a profitability and debt position, GameStop outshines both major competitors.
GameStop Best Buy RadioShack
EBITDA Margin 9.0% 4.5% 0.7%
Debt to Capital 0.0% 37.0% 56.0%

Yet, GameStop still lacks the respect it deserves. GameStop trades at a lower forward P/E multiple than Best Buy, but its expected growth is much more robust.

GameStop Best Buy
Forward P/E 8.7 11.5
5-Yr. Expected EPS Growth 10.0% 3.3%

Bottom line

GameStop no doubt has uncertainty related to the specifics on how the console makers plan to offer games, whether it be a move toward more digital or the prevention of sharing hard-packaged games. However, I think the recent sell-off is an overreaction. RadioShack and Best Buy are currently battling each other in a race to mobile, leaving GameStop Corp. (NYSE:GME) as the premier company for gaming.

Given GameStop’s current dividend yield and valuation, I think the downside is limited. In addressing the 25% of sales from used games, even if we assume fiscal 2015 EPS (January 2015) comes in 20% below analyst estimates at a P/E ratio of 11.5, GameStop would still manage to trade at current levels in 21 months.

The article What Will Stop GameStop? originally appeared on and is written by Marshall Hargrave.

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of GameStop and RadioShack. Marshall is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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