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GameStop (NYSE:GME) Misses Q3 Sales Targets


Full Report / December 06, 2023

Video game retailer GameStop (NYSE:GME) fell short of analysts' expectations in Q3 FY2023, with revenue down 9.1% year on year to $1.08 billion. It made a non-GAAP loss of $0 per share, improving from its loss of $0.31 per share in the same quarter last year.

GameStop (GME) Q3 FY2023 Highlights:

  • Revenue: $1.08 billion vs analyst estimates of $1.18 billion (8.8% miss)
  • EPS (non-GAAP): $0 vs analyst estimates of -$0.08 ($0.08 beat)
  • Free Cash Flow of $11.1 million, down 93.2% from the same quarter last year
  • Gross Margin (GAAP): 26.1%, up from 24.6% 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 an effort to punish hedge funds that had bet against the company. The event brought widespread attention to GameStop and raised questions about the role of individual investors in the stock market. Additionally, GameStop has been experimenting with new business models, including a plan to transform some of its stores into community-driven gaming hubs.

Electronics & Gaming Retailer

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).

Sales Growth

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 6.1% annually.

GameStop Total Revenue

This quarter, GameStop reported a rather uninspiring 9.1% year-on-year revenue decline, missing Wall Street's expectations. Looking ahead, the Wall Street analysts covering the company expect revenue to remain relatively flat over the next 12 months.

Gross Margin & Pricing Power

We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.

GameStop has poor unit economics for a retailer, leaving it with little room for error if things go awry. As you can see below, it's averaged a 23.2% 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 Gross Margin (GAAP)

GameStop produced a 26.1% gross profit margin in Q3, marking a 1.6 percentage point increase from 24.6% in the same quarter last year. This margin expansion is a good sign in the near term. If this trend continues, it could signal a less competitive environment where the company has better pricing power, less pressure to discount products, and more stable input costs (such as distribution expenses to move goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

This quarter, GameStop generated an operating profit margin of negative 1.4%, up 7.9 percentage points year on year. This increase was encouraging, and we can infer GameStop was more disciplined with its expenses or gained leverage on fixed costs because its operating margin expanded more than its gross margin.

GameStop Operating Margin (GAAP)

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 4.8%. However, GameStop's margin has improved, on average, by 8.7 percentage points year on year, an encouraging sign for shareholders. The tide could be turning.

EPS

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 Q3, GameStop reported EPS at $0, up from negative $0.31 in the same quarter a year ago. This print beat Wall Street's estimates by 100%.

GameStop EPS (Adjusted)

Between FY2020 and FY2023, GameStop's adjusted diluted EPS grew 77.7%, translating into a remarkable 25.9% average annual growth rate. This growth is materially higher than its revenue growth over the same period, showing that GameStop has excelled in managing its expenses.

Over the next 12 months, however, Wall Street is projecting year-on-year declines in EPS.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.

GameStop's free cash flow came in at $11.1 million in Q3, down 93.2% year on year. This result represents a 1% margin,

GameStop Free Cash Flow Margin

While GameStop posted positive free cash flow this quarter, the broader story hasn't been so clean. Over the last eight quarters, GameStop's capital-intensive business model and demanding reinvestment strategy have consumed many company resources. Its free cash flow margin has averaged negative 3.7%, poor for a consumer retail business. However, its margin has averaged year-on-year increases of 5.5 percentage points, showing the company is at least improving.

Key Takeaways from GameStop's Q3 Results

With a market capitalization of $4.55 billion, GameStop is among smaller companies, but its more than $909 million in cash on hand and near break-even free cash flow margins puts it in a stable financial position.

We were impressed by how significantly GameStop blew past analysts' EPS expectations this quarter. We were also excited its gross margin outperformed Wall Street's estimates. On the other hand, its revenue unfortunately missed analysts' expectations, driven by worse-than-expected hardware and software sales. Overall, this quarter's results seemed fairly positive and shareholders should feel optimistic. The market was likely expecting more top-line growth, however, and the stock is down 2.6% after reporting, trading at $14.45 per share.

Is Now The Time?

GameStop may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of GameStop, we'll be cheering from the sidelines. Its revenue growth has been weak over the last four years, but at least growth is expected to increase in the short term. And while its average annual EPS growth over the last three years has exceeded its peer group average, the downside is its projected EPS for the next year is lacking. On top of that, its relatively low ROIC suggests it has struggled to grow profits historically.

While we've no doubt one can find things to like about GameStop, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $13 per share right before these results, implying that they didn't see much short-term potential in GameStop.

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