In a world infatuated with the newest technology or latest gadget, Gamestop’s renaissance in 2013 is particularly curious. This is how the company describes itself, in its latest 10-Q:
GameStop Corp…is the world’s largest multichannel video game retailer. We sell new and pre-owned video game hardware, physical and digital video game software, accessories, as well as PC entertainment software, new and pre-owned mobile and consumer electronics products and other merchandise.
Reading the rest of the 10-Q, you get the sense that this is a declining company. Net sales across all its major categories have declined 5-25% over the last year. The company has been in cost cutting mode, so its net profit has only declined about 5%. But GME management simply blames the sales decline on the fact that we are in the late stage of the console cycle. Management does acknowledge that digital delivery of games is the wave of the future, but lays out little besides standard, cliched lines about “new investments” in the digital space.
Analysts have modeled in modest profit growth over the next couple years, clearly expecting a pick up in sales when the new console cycle gets underway. The Playstation 4 and the Xbox One are both going to be launched in the next few months, just in time for the 2013 holiday season. Interest in video games is expected to increase, and GME management is confident that it can cash in on that excitement.
Sales in GME have been essentially flat since 2008, though earnings have grown as management has kept costs under control. In fact, GME earned $2.33 per share in calendar year 2008, and is expected to earn around $3.25 in calendar year 2013, despite flat sales. Going forward, analysts project 5-10% sales growth (and 15-30% profit growth) over the next 2 years due to the console cycle. The stock currently trades at 16x earnings.
What’s most interesting about the chart is that earnings have hardly grown (and sales have declined) over the past 2 years, but the stock is more than triple were it was in the summer of 2012:
Back in the 2005-2007 rally, the stock was rallying because of rapid earnings growth. This time around, the stock has rallied without earnings growth, though from a much cheaper valuation level.
The real question is, were traders just mistakenly valuing the stock from 2009 to 2012, or is 2013 the mispriced valuation? Here is the trailing 12 month P/E for GME over the last 5 years:
If analysts are correct that GME can grow earnings 15-30% over the next 2 years, with sales growth of 5-10%, then the stock is still cheap. But in that case, what the heck were the shorts thinking earlier this year, when the stock had 40% of its float in short interest? They likely don’t buy the projections, especially since the company hasn’t grown sales in 5 years, through one full console cycle.
As I pointed out in today’s Macro Wrap, short interest in GME has declined from above 40% of the float 6 months ago to around 15% today. That’s around 25 million shares of short covering for a stock that trades about 3 million shares per day. A good part of the move in 2013 has been a simple short squeeze (though certainly not all of it).
Just as concerning for the bulls at current prices is the volume picture over the past 3 months. On-balance-volume, which measures volume on up days minus volume on down days, tries to assess whether buyers or sellers are more aggressive and more abundant. I rarely use it because I don’t think it has much value except in extreme cases. Well, GME is an extreme case. Here is the OBV chart overlaid with the stock chart:
The OBV indicator is in the same place today as it was in May, despite the fact that the stock is more than $10 above that level. That’s a huge divergence, and indicative of very weak volume support on the upside. In other words, bearish.
Add to that the much decreased short interest, the much higher valuation, and growth prospects that hinge on a holiday selling season that might already be more than priced in, and GME seems ripe for some significant selling for the first time in 2013.