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Good Result and Yet The Stock Fell 10+% – GameStop’s So Unloved

Chris Lee Susanto, Editor in Chief at Re-ThinkWealth

30 March 2018

What Happened to GameStop?

Gamestop stock hitting fresh 13 year low Source: Ycharts

The stock hit fresh near 13 year low despite the company doing pretty well during the earnings call on 28 March 2018. It closes at 10.39% down. It is not an easy day for any GameStop holders (except the short sellers), from my end, I am thinking where I could have gone wrong – or is the market wrong. I am more than willing to admit mistakes when I am wrong.

Delivered Solid Earnings

GameStop delivered solid earnings. It ended the year well – despite being in the industry they are in. Yes, the asset impairment (which is non-cash) does damage because it implies damage in one of their diversification efforts under the technology brand sector. But after adjustment to exclude the non-cash, they are pretty decent with free cash flow positive.

Bleak Outlook

The key here is that the management provided a bleak outlook to FY2018 (eps between $3 to $3.35). And they predicted a 2 to 6% decline in sales – with same-store sales being flat to -5%. This is expected and it is not too bad in my opinion because there might be a potential for a good surprise with a resolved partnerships with AT&T.

A Stock That is Unloved

GameStop is a stock that is unloved. Despite finishing the year well enough, the market is punishing them (more than what they deserved in my opinion).

by Analyst

The catalyst that resulted in GameStop falling so much in a day is a sell report by Bank of America’s analyst, Curtis Nagle (who is ranked #3533 out of 4759 analysts and a success rate of 48% according to tipsrank.com). He cut GameStop target price from $19 to $11.

“A cautious stance on GameStop’s business was justified heading into the company’s earnings, but the report made it clear the business is facing multiple structural headwinds that will continue hurting profits, Nagle said in the note. Some of the headwinds include game publishers shifting towards higher margin direct download offerings, growing popularity of online games for which GameStop has minimal exposure to, and rival game sellers like Amazon Prime offering discounts on games.

Nagle said these headwinds could also impact GameStop’s pre-owned gaming business, which has been historically a “critical source” of operating profit. GameStop’s non-gaming businesses like collectibles and Tech Brands were intended to offset losses in the core gaming business, the analyst wrote. However, while both businesses performed well so far the fact is increasing market competition is “likely to impede” earnings growth.

GameStop’s 55 million PowerUp Rewards members remains compelling, but it’s only strong enough to partially offset and not stop the multiple headwinds impacting multiple business lines.” – Nagle

But not all analyst are bearish, Colin Sebastian at Baird sees 40% return potential for GameStop. Colin has better Tipranks.com ranking as compared to Nagle, He has a 74% success rate and a high ranking of #14 out of #4759 analysts.

“GME reported solid 4Q17 results driven by lower-margin Switch hardware revenues, and strong contributions from new software. New CEO Mike Mauler announced a pivot towards optimizing existing stores and operations, including aiding awareness in the pre-owned category, albeit on lower segment margins (advertising and promotion.) Our lower price target reflects this shift; however, value-oriented investors could benefit from potential catalysts in Switch sales, revamped AT&T contract, E3 announcements and fall software lineup,” highlights Sebastian.

Standout elements of the print include new hardware, which soared 44.8% year-over-year in growth- quite a rise against the 8.8% year-over-year growth seen in the third quarter. Moreover, the analyst commends a sustained upturn in new software sales, which rose 12.4%, more than doubling the 5.4% momentum seen in the third fiscal quarter of 2017. These sales took advantage of an extra week compared to the year before along with meaningful gains in Call of Duty units.

Yet, Tech Brands revenues maintained a dip between product refocus and iPhone challenges, falling 14% year-over-year- more than the 10% seen in the fiscal third quarter. “Tech headwinds likely persist until AT&T contract terms modified,” explains the analyst, who recognizes the compensation structure had been unveiled in the first quarter. Sebastian continues, “On the call, management indicated FY18E tech brands operating profit should improve Y/ Y, but uncertainty around AT&T contract negotiations clouds the near-term outlook.” – Colin

Source: Smarter Analyst

by Investors and Market

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” – Benjamin Graham

Is it safe to say that as long as the company is making a positive return, the company will not go bankrupt?

The current retail investors, in my opinion, is too optimistic and willing to pay too high of a price for growth – but is too pessimistic to not pay even a low price for a business that is proven to generate cash.

What’s your thoughts?

My Thoughts

Current market capitalization or the price that the market is putting a tag on GameStop right now is 1.285B.

The latest figure for its free cash flow is 321.5M more than enough to cover its latest annual dividend payment of 155.2M (and currently yielding close to 11% based on current cost).

The latest cash and equivalents for GameStop is 864.40M more than enough to immediately pay off its long-term debt of 817.9M.

Total current assets are 2.539B, more than enough to cover its current liabilities of 1.916B.

No matter what valuation method I use, dividend discount model, comparables companies multiples or discounted cash flow, GameStop stock is undervalued to me.

Let’s do a simple dividend discount model exercise to prove my point. This is the formula for DDM: Value of stock= Expected dividends next period/(Cost of equity-Expected growth rate of dividends in perpetuity). Look at an article I wrote about it if you are keen where I valued Keppel DC REIT.

Value of GameStop using DDM if I expect 0% growth in dividends in perpetuity: $1.52/(0.08-0) = $19.

Value of GameStop using DDM if I expect 2% growth in dividends in perpetuity simply because there are indeed much more space to do that as FCF is way below dividends paid: $1.52/(0.08-0.02) = $25.30.

The current price of GameStop: $12.62.

on Buying More or Selling or Holding

I would buy more if I still have cash. But for now, I will hold on to my shares first.

on What I’m Glad I Did Not Do

If there is one thing that I am glad I did not do is that I did not use margin to buy any of my stocks – especially GameStop – because if I did, such a huge drop in the stock price, might force me to sell off all my stocks due to a margin call.

Surprisingly Calm

I am surprisingly calm with the drop in share price. My focus as an investor is getting more cash than the cost I put into GameStop. It could act as a dividend play while waiting for the management to figure things out.

Again, based on the facts below, I am not sure why Mr. Market would act like that.

“Current market capitalization or the price that the market is putting a tag on GameStop right now is 1.285B.

The latest figure for its free cash flow is 321.5M more than enough to cover its latest annual dividend payment of 155.2M (and currently yielding close to 11% based on current cost).

The latest cash and equivalents for GameStop is 864.40M more than enough to immediately pay off its long-term debt of 817.9M.

Total current assets are 2.539B, more than enough to cover its current liabilities of 1.916B.

No matter what valuation method I use, dividend discount model, comparables companies multiples or discounted cash flow, GameStop stock is undervalued to me.

Lets do a simple dividend discount model exercise to prove my point. This is the formula for DDM: Value of stock= Expected dividends next period/(Cost of equity-Expected growth rate of dividends in perpetuity). Look at an article I wrote about it if you are keen where I valued Keppel DC REIT.

Value of GameStop using DDM if I expect 0% growth in dividends in perpertuity: $1.52/(0.08-0) = $19.

Value of GameStop using DDM if I expect 2% growth in dividends in perpetuity simply because there are indeed much more space to do that as FCF is way below dividends paid: $1.52/(0.08-0.02) = $25.30.”

Disclosure: I am long GME.

Disclaimer: The information provided is for general information purposes only and is not intended to be a personalized investment or financial advice. 

Important: Please read our full disclaimer.

Thank you for your time reading my writings. 

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