Old Video Games Make New Profits

4/27/2009


  Recent Price
$34
  Dividend
$2.05 e
  Yield

6.0% e

  P/E Ratio
7
  Shares (millions)
1,447
  Long-Term Debt as % of Capital
40%
  52-Week Price Range
$49.85 - $29.96

One of few retailers to grow earnings in the past year, GameStop ($30; GME) operates the world’s biggest chain of video-game stores. The liquidation of rivals should help GameStop gain additional market share.

Video games attract an increasingly broad audience, helped by the popular Nintendo Wii and Guitar Hero franchises. Last year, video-game growth bucked the recessionary trend. In 2008, U.S. game sales rose 19% to $21 billion, according to market researcher NPD Group. Sales, however, fell 17% in March, offsetting growth in the first two months of the year because of a weaker slate of new games.

Despite rallying 38% this year, GameStop is an enticing play at just 10 times estimated-year ahead earnings, well below the average of 17 for S&P 500 retailers. GameStop is a Buy.

Business mix
In fiscal 2009 ended January, revenue rose 24% to $8.81 billion and same-store sales climbed 12.3%. GameStop’s largest business segment, new video-game software (42% of sales, 34% of gross profits), generated the best growth, with sales up 32%. Sales of new video-game hardware (21%, 5%) grew 11%. Sales of used products (23%, 43%) climbed 28%, accelerating in the January quarter.

Nearly three-quarters of sales come from the U.S., with the balance generated in Europe, Australia, and Canada. The November acquisition of Micromania for about $700 million should strengthen European operations.

Play, beat, return
The trade-in business model encourages consumers to unlock the value in old games and consoles, applying the funds toward new products. While used games often sell for $5 to $10 less than new ones, they generate significantly higher profit margins.

Competitors are trying to loosen GameStop’s grip on the trade-in market. RadioShack ($10; RSH) plans to expand an electronics trade-in program, and Best Buy ($40; BBY) and Toys “R” Us may start trading used games. Also, Amazon.com ($79; AMZN) now allows customers to send in games and receive credit toward anything on the site.

While rivals are getting more aggressive, past efforts to outplay GameStop in the secondhand market have failed. GameStop says people who sell games want cash immediately to buy new games. Otherwise, more would sell them on Internet auction sites like eBay ($14; EBAY). The company says 70% of trade-in funds are used immediately for purchases.

Digital downloads probably represent a greater risk to GameStop’s profits in the years ahead, though users can download only add-ons to games and still must purchase the original games through retail channels. The impact on GameStop over the next two to three years seems limited.

Conclusion
Wall Street anticipates per-share profits will rise 11% in the April quarter and 20% in the year ending January. If growth continues, GameStop’s P/E ratio should expand in coming months — an increase to 13 times year-ahead earnings over the next nine months seems reasonable. Such multiple expansion would equate to a stock price of $35 to $42, based on consensus profit expectations. An annual report for GameStop is available at 625 Westport Parkway, Grapevine, TX 76051; (817) 424-2000;
www.gamestopcorp.com.

GAMESTOP
 
Quarter

    Per-Share
     Earnings*

Sales
Change

      Quarterly
      Price Range

P/E Ratio
Range

Jan '09 $1.34 vs. $1.14 +22% $28.23 -

$16.91

13 - 8
Oct '08 0.34 vs. 0.31 + 5% 47.69 - 24.09 22 - 11
Jul '08 0.34 vs. 0.13 + 35% 57.20 - 37.62 29 - 19
Apr '08 0.37 vs.

0.15

+ 42% 59.13 - 40.78 34 - 24
           
Year
(Jan.)

Sales
 (Bil.)

Per-Share
Earnings*
Per-Share
Dividend

52-Week Price Range

P/E Ratio
Range

2009 $8.81 $2.40 $0.00 $59.13
-
$16.91 25 - 7
2008 $7.09 $1.75 $0.00 63.77
-
24.95 36 - 14
2007 $5.32 $1.00 $0.00 29.21
-
17.93 29 - 19
2006 $3.09 $0.92 $0.00 20.5
-
9.32 22 - 10
             
————————————————— Quadrix Scores † —————————————————
Overall Momen-
tum
Value Quality Financial
Strength
Earnings
Estimates
Performance
98 82 77 94 72 97 80

   * Earnings exclude special items.
   † Quadrix® scores are percentile ranks, with 100 the best.

 


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