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Dividend Investor
Safe Income and Dividend Growth

March 24, 2017

GameStop (GME) reported fourth-quarter and full-year 2016 results after the market closed yesterday.

Switching GameStop (GME) from Buy to Hold

GameStop (GME) reported fourth-quarter and full-year 2016 results after the market closed yesterday. Earnings per share beat estimates, but revenues fell short and management’s 2017 EPS guidance disappointed analysts. The stock fell 11.5% in after-hours trading, and looks set to open about 11% lower this morning.

In the fourth quarter, GameStop’s revenues fell 14%, to $3.05 billion, slightly more than the 12% drop analysts were anticipating. However, adjusted fourth-quarter EPS of $2.38 were well above the $2.29 analysts were expecting (and only 0.8% lower year over year).

Full-year results were similar. Sales of $8.61 billion fell short of expectations (the average estimate was $8.64 billion), and were 8% lower than in 2015. But the 3.3% decline in EPS to $3.77 was smaller than the 5.4% decline (to $3.69) that analysts were expecting.

The usual suspects were responsible for the sales misses: new hardware sales fell 29% in the fourth quarter, and new software sales fell 19%. Pre-owned sales, which account for over 20% of revenues, fell 6.7%. Management pointed out that 2016 was the third year in the console cycle, which is typically weak. Hardware sales (and related game sales) may get a boost in 2017 from the release of the Nintendo Switch (earlier this month) and the Microsoft Scorpio (at the end of the year).

While they didn’t offset the weakness in its core areas, GameStop’s newer businesses are healthy. Collectibles revenue grew 28% last year, to $494 million, the high end of expectations. Management expects sales to hit $1 billion by the end of 2019. And thanks to the acquisition of over 500 new stores, technology brands sales rose 52% for the full year, to $814 million. The high margins at the tech brands stores contributed to GameStop’s third year in a row of margin improvement.

However, what sent the stock down 11% was management’s simply lousy 2017 guidance. Revenue is expected to be between 2% lower and 2% higher, in line with analysts’ estimates. However, management expects EPS to fall between 9% and 18%, to $3.10-$3.40. That includes a 25-cent impact from higher expected taxes, but even adjusting for that impact, the high end of management’s range is still below analysts’ previous average estimate of $3.76.

Management is anticipating a few one-time impacts, including shifting the end of their fiscal year into February, but for the most part, they’re simply admitting that sales growth at the new businesses just isn’t offsetting declines in software and hardware yet. There are some bright spots in the guidance: collectibles revenues is expected to increase 30% to 40%, as GameStop stores devote more floor space to it, and sales at the technology brands stores could get a nice boost when the new iPhone is released in the second half of the year. However, the first half of the year is likely to be disappointing; there’s a dearth of AAA video game releases and tech consumers often hold off on mobile purchases ahead of the iPhone release.

Bottom line, I’m moving GME to Hold today, and we’ll watch what happens over the next few days. The stock is very undervalued, and still above its November lows. We’ll watch to see if support develops.