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What's Next for GameStop (GME) Stock After Dismal Q3?

Christopher Vargas

GameStop GME shares plummeted over 15% at one-point Wednesday as Wall Street widely sold off the stock after it reported its rough Q3 financial results. GME stock has now cratered over 56% in 2019 and it currently seems like there may be no end in sight.

The company’s weak third-quarter financial results prompted management to chop its fiscal 2019 forecast to $0.10-$0.20 per share from $1.15-$1.30 per share. The massive cut to its forward guidance darkened the outlook for the struggling video game retailer.

Now investors and Wall Street are left to wonder if GameStop will ever get out of this slump?

Hardware & Used Game Sales Decline Steepens

GameStop’s tumultuous third quarter was driven by a steep decline in its hardware and used games businesses. Comparable store sales crashed 23.2%, which helped drive total revenue down 26%. New hardware sales tumbled 46%, while new software sales slumped 32.6%, and accessories sales declined over 13%.

The rough quarterly performance from hardware sales was due to the next generation consoles from Microsoft MSFT and Sony SNE that are set to debut in Q4 2020. GameStop CEO, George Sherman, stated during the conference call that “Our third quarter results continue to reflect the prevailing industry trends, most notably the unprecedented decline in new hardware sales.”

In addition to the struggles in hardware sales, the company’s most profitable segment, used games, continued its decline as well. Pre-owned and value video game products saw sales slip 13.3% Y/Y, which added to a long streak of declines. This particular business segment has been decreasing since the beginning of 2016 and its declines have accelerated as the current generation of consoles near the end of their lifecycles.

The blow to used games is detrimental to GameStop’s overall financial health as its used games bring in double the profit of new games and nearly quadruple the margins that hardware sales generate. If GameStop can’t find a way to rejuvenate its used games sales, the company will likely continue to see its bottom-line freefall.

Can Stock Buybacks Help?

GameStop took advantage of its low stock prices during the third quarter and bought back a whopping 22.6 million shares for $115.7 million in the quarter, at $5.11 per share. The third quarter buyback followed buybacks in Q2 and Q1, which brought the 2019 buyback total to 34.6 million shares for $178.6 million, at an average price of $5.14 per share. By the end of Q3, there were only 67.8 million shares outstanding, which was down a substantial 34% on the year.

The stock buybacks could be a good sign from GameStop, as it bought back shares below its book value instead of trying to diversify its revenue streams through capital-intensive initiatives. At the end of the third quarter, GameStop had $290 million in cash and cash equivalents and $419.4 million in debt.

Its balance sheet might also be replenished during the holiday season, which might put the company in a position to buy back even more of its stock or finance a different initiative.

However, for these stock buybacks to work in GameStop’s favor, its shares need to truly be undervalued. The next generation gaming consoles would have to rejuvenate hardware and software sales for the next couple of years, and used games sales would need to take off as well. But if digital games continue to dominate the market it could accelerate the decline in used games, which would cause the firm more profitability issues.

Either way, GameStop would have to wait until Q4 2020 to potentially receive a stimulus package from the release of the new consoles. Shareholders will have to weather the storm until that potential bailout.

The gaming industry has widely welcomed subscription services like Xbox Game Pass, Playstation Now, and Apple Arcade AAPL. Modern consumers are now fixated on subscription services that gives them access to a library of content. GameStop could potentially look to do something in this realm as an alternative to its stock buybacks.

Bottom Line

GameStop shares looked cheap ahead of its third quarter earnings report as it traded for around 5X its forward earnings, which was less than the industry average of 14.1X forward earnings. GameStop’s new midpoint for its lowered full year forward guidance is 88% lower than its previous guidance, which puts its new PE ratio at around 37X.

The company’s updated valuation may deter value seeking investors, especially after its brutal Q3. With more video game purchases moving to the digital marketplace, and profits spiraling lower, GameStop looks more like an investment for those with higher risk tolerances, or a trader’s stock.

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