Name That Trade – The $GME is the Game

by Dan March 26, 2015 12:17 pm • Commentary

Event: GameStop (GME) reports their Q4 results tonight after the close. The options market is implying about an 8% one day move.  The March 27th weekly expiration 39 straddle is offered at about $3.10, if you were to buy that you would need a move above $42.10, or below $35.90 by Friday’s close to just break-even.  The average move over the last 4 quarters has been about 7% with last quarter the stock suffering a 13.7% decline.  

Price Action / Technicals:  The stock is up about 25% from the 2015 lows, and up nearly 16% on the year.  Despite the strength over the last couple months, the stock remains in a massive downtrend from the seven year highs made in 2013, making a series of lower highs and lower lows:

[caption id="attachment_52248" align="aligncenter" width="600"]GME 3yr chart from Bloomberg GME 3yr chart from Bloomberg[/caption]

The stock bounced off of the mid January lows after the company reiterated prior guidance on January 14th (circled below), per Bloomberg:

New software sales, the category that includes games, rose 5.8 percent in the period, driven by a 94.4 percent increase in PlayStation 4 and Xbox One software, the Grapevine, Texas-based company said yesterday in a statement. Sales of new hardware declined 32 percent in the nine-week period ended Jan. 3.

The company reaffirmed its fourth-quarter earnings forecast of as much $2.24 a share. Analysts projected $2.16,

[caption id="attachment_52249" align="aligncenter" width="600"]GME year to date chart from Bloomberg GME year to date chart from Bloomberg[/caption]

Fundamentals/ Valuation: While many have called for the death of GME’s sales model, (specifically physical software sales), the company is set to report mid teens eps growth for the fiscal year, and consensus estimates are calling for the same in fiscal 2016. With the stock trading at a little below 10x expected earnings of about $4, the stock is far from expensive to its history and to peers like BBY at 15x.

Sentiment: nearly 45% of the float is short, obviously reflecting the controversial nature of the stock and the company’s prospects.  Wall Street analyst remain slightly bullish though with 14 Buy ratings, 8 Holds and No Sells with an avg 12 month price target of about $47.

Estimates from Bloomberg:

-4Q adj. EPS est. $2.16 (range $2.10-$2.25); co. forecast $2.08-$2.24 (Nov. 20)

-4Q rev. est. $3.6b (range $3.41b-$3.76b)

-4Q comp sales est. -1.8% (Consensus Metrix avg of 14); co. forecast comp sales down 1%-2.5%

-4Q gross margin est. 27.9% (range 26.1%-29.1%)

-1Q EPS adj. EPS est. 66c (range 54c-87c)

-FY16 adj. EPS est. $4.04 (range $3.80-$4.36)

MY VIEW:  The stock is certainly cheap, with a 3.6% dividend yield (recently raised), $500 million share buyback and clean balance sheet and 45% short interest, the stock seems like a tough short.  That said, the short thesis for bricks and mortar electronics retailers, with increasing competition from the likes of Amazon, and the secular shift towards cloud computing, and Saas seems to be a hard one to bet against.  Despite the stock’s gains from the lows, expectations are not exactly high with many analysts already expecting guidance to be affected by the strength of the dollar (about 30% of sales are from overseas).

The $3 implied move seems fair.

We’re not involved but we looked at some trades for those with stronger views or an existing position:

Neutral/Yield Enhancement: Buy April 37.5/40/42.5 call fly for .65. This risks .65 with the potential to make/add in yield 1.85 if the stock underperforms the expected move. This is a little tight and those strikes can be widened with higher premium risk but a greater chance of success.

Bullish: Buy April/May 44 call calendar for .30. It’s difficult to take a bullish long premium stance into the event without risking a big percentage of the underlying in order to do so. (like call spreads). Therefore, a call calendar could make sense for those looking for GME to get back towards the mid 40’s. The ideal situation is for the stock to be up on earnings but not through the $44 level.

Bearish/Hedge against long: April 38/33 put spread for 1.20. Probably not the greatest outright bet in the world but for those that feel really strongly or those looking to protect a long, this 1.20 at risk for the potential of 3.80 in reward makes some sense. A breakeven of $36.80 isn’t that far away.