Video game retailer GameStop (NYSE:GME) beat analysts' expectations in Q2 FY2023, with revenue up 2.45% year on year to $1.16 billion. The company didn’t provide any forward revenue guidance. Turning to EPS, GameStop made a non-GAAP loss of $0.03 per share, improving from its loss of $0.35 per share in the same quarter last year.
GameStop (GME) Q2 FY2023 Highlights:
- Revenue: $1.16 billion vs analyst estimates of $1.14 billion (1.97% beat)
- EPS (non-GAAP): -$0.03 vs analyst estimates of -$0.14
- Free Cash Flow was -$119 million compared to -$124 million in the same quarter last year
- Gross Margin (GAAP): 26.3%, up from 24.8% in the same quarter last year
Drawing gaming fans with demo units set up with the latest releases, GameStop (NYSE:GME) sells new and used video games, consoles, and accessories, as well as pop culture merchandise.
Over time, physical consoles and cartridges have lost some relevance, as more games are delivered digitally. In response, GameStop established a digital storefront on its website where customers can purchase digital game downloads and in-game content. When a customer makes a purchase, they receive a digital code that can be redeemed on the platform of their choice, such as Xbox Live. GameStop also offers the option to purchase digital content in-store, where employees can help customers navigate the process and answer any questions they may have.
The core customer of GameStop is typically a young, male gamer looking for the latest video games and accessories. Stores also offer trade-in opportunities for customers who want to sell or exchange used games and consoles for store credit. The size of an average GameStop store is small, around 1,500 square feet. They are located in malls or shopping centers alongside other mass market retailers. The stores are laid out with displays of the latest video games and consoles at the front of the store, while used games and accessories are often located toward the back.
GameStop's competitors include other video game retailers like Best Buy and Walmart, as well as online retailers like Amazon and digital gaming platforms like Steam. Some of these competitors, like Best Buy and Walmart, are public companies, while others, like Steam, are private.
One interesting fact about GameStop is that the company was at the center of a trading frenzy in early 2021 when a group of amateur investors on Reddit drove up the price of GameStop's stock
After a long day, some of us want to just watch TV, play video games, listen to music, or scroll through our phones; electronics and gaming retailers sell the technology that makes this possible, plus more. Shoppers can find everything from surround-sound speakers to gaming controllers to home appliances in their stores. Competitive prices and helpful store associates that can talk through topics like the latest technology in gaming and installation keep customers coming back. This is a category that has moved rapidly online over the last few decades, so these electronics and gaming retailers have needed to be nimble and aggressive with their e-commerce and omnichannel investments.Competitors offering video games and video game accessories include Best Buy (NYSE:BBY), Walmart (NYSE:WMT), and Amazon.com (NASDAQ:AMZN).
GameStop is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex high growth rates because it's growing off a smaller base than its larger counterparts.
As you can see below, the company's revenue has declined over the last four years, dropping 7.18% annually.
This quarter, GameStop reported decent year-on-year revenue growth of 2.45% and its revenue of $1.16 billion topped Wall Street's expectations by 1.97%. Looking ahead, Wall Street expects revenue to decline 3.26% over the next 12 months.
Gross Margin & Pricing Power
As you can see below, GameStop has averaged a poor 23% gross margin over the last two years. This means the company makes $0.23 for every $1 in revenue before accounting for its operating expenses.
GameStop produced a 26.3% gross profit margin in Q2, marking a 1.4 percentage point increase from 24.8% in the same quarter last year. This margin expansion was comforting as it could signal that the company was operating in a less competitive environment with higher pricing power, less pressure to discount products, and more stable input costs (such as distribution expenses to move goods).
Operating margin is an important measure of profitability for retailers as it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, GameStop generated an operating profit margin of negative 1.43%, up 7.8 percentage points year on year. This increase was encouraging, and we can infer that GameStop was more disciplined with its expenses or gained leverage on fixed costs because its operating margin expanded more than its gross margin.Unprofitable publicly traded companies are few and far between in the consumer retail sector, and over the last two years, GameStop has been one of them. Its high expenses have contributed to an average operating margin of negative 5.59%. However, GameStop's margin has improved, on average, by 6.4 percentage points year on year, an encouraging sign for shareholders. The tide could be turning.
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q2, GameStop reported EPS at negative $0.03. This print beat Wall Street's estimates by 78.6%, a welcome development that should delight shareholders.
Between FY2020 and FY2023, GameStop's adjusted diluted EPS dropped 143%, translating into 47.6% average annual declines. In a secularly declining sector such as consumer retail, we tend to steer our readers away from companies with multiple years of falling EPS. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
GameStop burned through $119.2 million of cash in Q2, in line with its cash burn last year. This result represents a negative 10.2% free cash flow margin.
Over the last two years, GameStop's capital-intensive business model, lack of cost discipline, and demanding reinvestments to stay relevant with consumers in an increasingly competitive market have drained many company resources. Its free cash flow margin has been among the worst in the consumer retail sector, averaging negative 6.74%. However, its margin has averaged year-on-year increases of 18.1 percentage points. Shareholders should feel optimistic as this is a good sign for the business.
Return on Invested Capital (ROIC)
GameStop's bottom-tier returns on capital suggest it's not only struggled to find compelling reinvestment opportunities but also made some mistakes along the way. The company's five-year average ROIC is negative 10.3%, among the worst in the consumer retail sector.
We like to track ROIC because it tells us about a company’s prospects for profitable growth and its management team's ability to achieve it through capital allocation decisions such as organic investments, acquisitions, and share buybacks. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from GameStop's Q2 Results
Sporting a market capitalization of $5.85 billion, GameStop is among smaller companies, but its more than $1.19 billion in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
We were impressed by how significantly GameStop blew past analysts' EPS expectations this quarter. That really stood out as a positive in these results. The company also beat Wall Street's revenue estimates, driven by outperformance in its hardware and accessories segment. The stock is up 1.33% after reporting and currently trades at $19.02 per share.
Is Now The Time?
When considering an investment in GameStop, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of GameStop, we'll be cheering from the sidelines. Its revenue growth has been weak, but at least that growth rate is expected to increase in the short term. On top of that, unfortunately its relatively low ROIC suggests suboptimal profitability prospects and its operating margins reveal poor profitability compared to other retailers.
While we've no doubt one can find things to like about GameStop, we think there might be better opportunities in the market, and at the moment, don't see many reasons to get involved.
Wall Street analysts covering the company had a one-year price target of $13.1 per share right before these results, implying that they didn't see much short-term potential in GameStop.
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