13 February 2008

GameStop - GME - A Zacks Top 10 for '08

It wasn't hard to ascertain which company Zacks meant from the following description:

Stock #5: Video game seller to win big. Now is the time to own this stock. Profits from next-generation video game systems are expected to pour in for at least the next two years.

I'm not sure Zacks' plug got it right. Apparently, the profits won't necessarily come from the sale of the Wii, Xbox 360, PS3, and handhelds, but from GameStop's used game business.

From Morningstar:

While the availability of new video game software and consoles attracts gamers to the company's stores, sales of used games generate more than 40% of GameStop's profits. The company has no pricing power on new products as retail prices are dictated by manufacturers and competitive forces keep margins low.

However, the company's market in the trading of used games is unique among North American retailers and gives GameStop pricing flexibility. GameStop allows gamers to trade in used games and video game hardware for discounts on new purchases. The company then turns around and sells the used products to customers looking for deals at below prevailing market prices for new products. GameStop's market in used products thus provides the company with a dual edge over competitors.

First, hardcore gamers who like to play the latest hit game are more likely to purchase new games from GameStop as they can trade in games they have outgrown for discounts toward their purchase.

Second, value-oriented casual gamers--who tend to be comfortable with playing older games at a lower price point--are more likely to look to GameStop for their purchase of used games as the company's inventory of such products is very robust. This unique position allows GameStop to make a handsome profit from its trade-in used games, with gross margins approaching 50%, compared with gross margins of about 20% on new games.

That's an impressive business model that allows GameStop to profitably participate in the churning of video games as they are sold and re-sold. And I particularly appreciate the concept that GameStop draws in the spectrum of video game shoppers. Using outmoded music store references, it's like GameStop has combined the Top-40 draw of a Sam Goody

with the trade-ins and back catalog of a used record store like Vintage Vinyl.

Speaking of the outmoded dinosaur record store business model, Morningstar sees threats to GameStop's business on the horizon, but not in the one-year investing timeframe for these Zacks Top 10 stocks:

[T]he company's business model could be compromised in the long run by industry forces beyond its control. Video game publishers are increasingly attempting to improve profitability by selling incremental game updates directly to gamers through online micro-transactions. A steady stream of exciting new features could persuade gaming enthusiasts to hold onto their library of games, thereby drying up the supply of used games. Additionally, rapid growth in residential Internet bandwidth has the potential to enable direct delivery of new games to gamers over the Internet, bypassing retailers like GameStop. We do not expect either of these possibilities to materialize and impact GameStop's business in the next two to three years; however, the threat of technological disruption over the next five to 10 years prevents us from assigning a moat to GameStop at this time.

So is it a good time to buy shares of GME? I found a post from Market Intelligence Center, via Google Finance, that says no:

GameStop (GME) NewsBite - Insider Trading Indicates Bearishness on GameStop
Posted on Wednesday, February 13, 2008 1:35 PM
GameStop Corp. (GME) opened at 49.38. So far today, the stock has hit a low of 46.25 and a high of 49.52. GME is now trading at 48.00, down 1.10 (-2.23%). The stock hit its 52 week high of 63.77 in December and set its 52 week low of 24.95 in March. GME has been climbing for the past year. A quick look over insider trading shows that insiders have sold over $2 million worth of holdings in GameStop over the last three months, with no buying activity, indicating that we could see some additional weakness ahead. Technical indicators for the stock are bearish but slightly improving while S&P gives GME a neutral 3 STARS (out of 5) hold rating. If you're looking for a hedged play on this stock, consider a March bear-call credit spread above the $55 range. GME stock could rise up to 14.6% before expiration and this position would still be profitable.

Bold added by yours truly.

Looking at the daily chart for GME:

The RSI(2) of 5 gives a short-term buy signal.

Looking at the weekly chart for GME:

We see a consistent bullish trend, with the share price approaching the 50-week moving average. Share of GME have not crossed that 50-week moving average since mid-2006, and even then, shares did not fall far below that average.

My reading of the charts is that it's a fine time to pick up shares.

Trader Mark over on Seeking Alpha lamented Gamestop's "No Win Situation" while retaining his essentially bullish outlook on the company's prospects:

Very tough sledding... Gamestop (GME) is a great example. I have opined in the past that the last thing consumers will give us is electronics - whether it be gadgets, video games, etc. To show how hard it is to invest in any form of retail right now, all this company did was post a blow out quarter, raise guidance, perform... perform... perform... and the stock is down 5%. After dropping from $62 to $55 in the past week. Just treacherous out there, and anything within six degrees of any consumer is being shot.

If so many other names I like were not "on sale," I would be heading into Gamestop which is a de facto monopoly on video game retail sales... gamers will cut back on eating before they give up their games! But that doesn't matter in this type of market. This reminds me of Research in Motion (RIMM) - the stock just reported two weeks ago, provided great guidance and said they see no slowing. Not a week later, the stock is crushed on fears of slowing! Which means guidance is not even worthwhile after a week, because fears are so high out there. Toss out what the company said, literally 10 days ago, because the End of Days is approaching. This seems to be the approach.

I always find it interesting that investors want companies to beat earnings... if they don't beat them, they crush a stock... but when a company issues conservative guidance (that it knows it can beat), it still gets crushed. There is no winning and that's the part of earnings season I really hate. I love the "information acquisition" part; I hate the investor reaction part.

GameStop Corp (GME), the largest U.S. video game retailer, raised its quarterly earnings estimate on Thursday after holiday season sales rose sharply on blockbuster games like "Guitar Hero."
But shares of GameStop fell 6 percent even after the announcement as analysts, while bullish on the stock, cited concerns that video game sales could not maintain their momentum over the short term.
"First of all, the numbers were lights out," said Mike Hickey, an analyst with Janco Partners Inc. "But the concern is that their same-store sales guidance was raised to 15.5 percent to 16.5 percent, which is measurably below the 20 percent they just produced for the holiday period." (notice the word raised... they raised guidance but since it was not as high as the holiday period its 'bad'. Don't people realize this is a retailer? Retailers have higher sales during the holiday period - hello?)
"But I will say this is a conservative management team, and we continue to like the name. They appear to be doing all the right things."
GameStop's comparable store sales for the holiday period increased 20 percent, while total store sales for the period rose 34.7 percent, it said. Given the rise, the retailer increased its fiscal fourth quarter 2007 comparable-store sales estimate from a range of 7 percent to 9 percent to a range of 15.5 percent to 16.5 percent. (last I checked, that was a good thing.... but apparently not anymore)
GameStop also boosted its fourth-quarter diluted earnings per share estimate to a range of $1.09 to $1.10. Full-year earnings per diluted share are now estimated to be in a range of $1.75 to $1.76, or 13 cents per share higher than guidance issued in November. (not good enough... because video games may slow in 2014 - sell!)
Another analyst, Arvind Bhatia of Sterne Agee, reiterated his buy rating on the stock and said the pullback marked a ripe time to buy shares. "We think even though the stock is down today on the 'sell on news phenomenon,' we were fundamentally more impressed after the release than before the release," Bhatia said. (sell the news? what have they been selling each day of the past week? sell the pre-news?)
And this is why this market is completely treacherous right now - logic does not apply, and good stocks are thrown out with bad. Stock picking is rather useless as 'baby bathwater' theory is now upon us. How long it lasts is the open question and if anyone has that crystal ball, drop me a line. But when I see action like this, the contrarian in me wants to get very very long this market. Oh wait, already am...

Fundamentally and technically, GameStop looks like a solid addition to a buy-and-hold-and-ignore portfolio, the kind that Zacks promoted with their Top 10 package.

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