If the younger crowd likes anything, it likes diversions.

Video games are a leading diversion, both here and abroad. Global video-game revenue runs at over $100 billion annually, according to data aggregator and analyzer Statista.

[ad#Google Adsense 336×280-IA]That should be good news for GameStop (NYSE: GME), the world’s largest retailer of video-game products and PC entertainment software. GameStop peddles its wares through 3,959 U.S. and 2,024 international locations.

It should be good news, but it’s not. GameStop’s shares are down 40% over the past year.

Obsolescence is the overarching concern. Downloads will decimate disks. Investors conflate GameStop’s business model with the likes of Blockbuster and Kodak.

It’s Cyclical

The bears cite GameStop’s poor results in the latest quarter as evidence that digital downloads are the future. Overall company revenue was down 4.3% compared to the year-ago quarter; EPS was down 7.4%. Passions were further stoked by the news that same-store sales declined 6%.

It all sounds so dire, but it’s less dire than investors perceive. GameStop is no Blockbuster or Kodak.

The video-game business is a cyclical business. GameStop’s revenue trended meaningfully higher from 2007 through 2012. The cycle peaked in 2012, and industry sales growth has remained flat since. Nevertheless, GameStop generated growth in a flat market.

Growth will cycle up with the release of new video-game consoles and new video games. The up-cycle will likely start anew next year. Nintendo’s next console, code-named NX, is set to hit store shelves in March 2017.

But what about the digital-download threat?

Broadband speeds leave much to be desired. The ever-expanding size of games causes significant issues for digital-only machines. Downloads can take an hour or up to a day for larger bandwidth-devouring games.

Storage is another issue in a digital-only environment. There is a limit to the number of games that can be stored on a hard drive at any one time.

GameStop’s New Ventures

And unlike Blockbuster and Kodak, GameStop isn’t simply watching the world go by. It’s investing in new ventures to generate growth and to mitigate video-game cyclicality.

Last year, GameStop acquired ThinkGeek, an online and wholesale retailer that develops and sells pop-culture themed collectibles, apparel, gadgets, electronics, and toys. ThinkGeek expands GameStop’s global distribution platform and broadens its product offering.

So far, so good. GameStop’s collectibles sales were up 250% to $82.3 million year over year in the latest quarter. Collectibles revenue should hit management’s full-year goal of $450 million to $500 million. Looking ahead, management expects collectible sales to double to $1 billion by 2019, which isn’t unreasonable. The market is growing at a 10% annual clip.

Growth Opportunity

GameStop’s Tech Brands segment is yet another growth opportunity. This segment includes an authorized reseller relationship with AT&T (NYSE: T). The AT&T hookup provides a strong pipeline for future same-store growth. The segment also includes Simply Mac, which sells and repairs Apple (NASDAQ: AAPL) devices.

In the last quarter, Tech Brands sales were up 62% to over $165 million; operating earnings grew to $18.8 million compared to $3.1 million a year earlier.

Hefty GameStop Dividend

GameStop’s management projects overall operating earnings to grow 3% to 5% annually through 2019. It expects EPS to range between $3.90 to $4.05 this year. This is despite the fact management expects same-store sales to range between negative 3% to flat. The video-game cycle might be closer to trough than a peak, but GameStop continues to generate earnings growth.

And that earnings growth easily covers GameStop’s ample dividend, paid at $1.48 per share annually. The GameStop dividend also has grown annually, from $0.80 per share five years ago to $1.48 per share today. The GameStop dividend yields 5.2% at the current market price.

The GameStop dividend is also on sale. GameStop shares trade at just over seven times current earnings estimates. They trade at less than seven times 2017 EPS estimates for $4.30. The S&P 500 trades at 16.8 times forward earnings by comparison, and S&P earnings are expected to grow only 2% year over year.

— Steve Mauzy


Source: Wyatt Investment Research