GameStop’s sales increase is too small, too late

GameStop (NYSE: GME) recently provided a update on its results for the first fiscal quarter (the period ending in early May) following the novel coronavirus. As expected, same store sales (comps) cratered, falling 23% for the first nine weeks of the quarter. A positive point underlined by management is that US compositions rose 3% in the first three weeks of March (just before stores close), but it’s too short a period to draw any conclusions.

The company has approximately 5,500 stores worldwide, but two-thirds are located in the United States. Of more than 3,600 stores in the United States, two-thirds continued to offer curbside pickup. These retained more than 90% of the company’s expected sales volume after the stores were forced to close by the pandemic.

Although the pandemic has affected sales, it is unfair to judge the company’s performance based on this very unusual time frame. In the interest of fairness, I reviewed the performance of the company before action was taken to stop the spread of the coronavirus.

Image source: Getty images.

Business pointing down

Simply put, GameStop’s business performance has been poor over the past few years. This includes a 19.4% drop in sales in fiscal 2019.

Management attributed the weak sales to various factors. Much of the weakness was due to the game console cycle, since Microsoft and Sony are expected to launch new systems at the end of 2020. However, this does not fully explain the decline in sales. Software sales, which accounted for 46.5% of GameStop’s revenue for fiscal 2019, have been declining in recent years. Last year, software sales fell 22% to $ 3 billion. Part of that was due to underperforming store closings, but most of the decline in software sales was due to weaker lineups. There were fewer physical games released last year, and they didn’t sell as well as in fiscal 2018.

While GameStop may see its sales increase when new game consoles hit the market, the company will continue to lose ground on game sales as the trend for digital downloads accelerates. Microsoft already has a version of its gaming system – Xbox One S All-Digital Edition – that doesn’t have a disc slot at all. Instead, it supports downloaded games and streaming content. In addition, Sony offers a subscription service that allows subscribers to download games.

There are many other companies, large and small, that offer games online. This means that there is a significant and growing threat to GameStop sales.

The good news is that GameStop’s gross margin fell from 27.9% to 29.5% in fiscal 2019. Management has attributed a mixed change to low-margin gaming consoles – which will likely prove to be true. fleeting after the news launched – and better inventory management which resulted in lower promotional activity. While the increase in gross margin is nice to see, GameStop needs to make more progress to turn around its operations.

An activist in the middle

The company’s performance led management to implement GameStop Reboot’s turnaround plan in 2019. This involves steps such as cutting costs and building GameStop’s omnichannel capabilities.

As adjusted selling, general and administrative expenses decreased by $ 130 million to $ 1.85 billion last year, and the ability to order online and pick up items in-store has no doubt helped sales in the first quarter, these measures do not lead to increased profitability. Last year, GameStop adjusted operating income fell 81% to $ 62.3 million. With weakening sales and profitability, GameStop shares have fallen 84% in the past five years.

GME chart

Performance of GameStop actions, given by YCharts.

No wonder the company aroused the wrath of a group of activist investors which owns more than 7% of the shares of GameStop. Hestia Capital and Permit Capital are seeking two seats on GameStop’s 10-member board of directors. The activist group wants its board representatives to lobby for cost cuts, executive compensation changes, improved cash flow and better use of GameStop’s gaming platform.

I think the business needs a change, but activists haven’t provided many details on how they would change the course of GameStop. The challenge is tall, given the undeniable trend in digital game downloads, making it difficult to see how GameStop will revitalize its business. For me, this is a game not worth playing.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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