This Store Isn't Playing Games

04/15/2010 1:00 pm EST

Focus: STOCKS

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says a giant video game retailer is ready to profit from the spread of video games’ appeal throughout the population.

GameStop (NYSE: GME) is the world’s largest video game retail chain. The company sells new and used hardware and software.

New video game hardware accounted for 21% of fiscal 2010 net sales and 5% of gross profits. Stores sell Sony’s PlayStation 3 and PSP, Microsoft’s Xbox360, and Nintendo’s Wii, and DS.

New video game software produced 42% of net sales and 34% of gross profits. GME sells more than 1,000 new software [titles]. Used video game products generated 23% of net sales and 43% of gross profits. GME sells 3,000 used software [titles] at an average price of $18, [versus] an average price of $43 for new software.

Customers can trade in used hardware and software for store credit, which they usually apply towards the purchase of new merchandise. Used games and systems have helped GME tap into a demographic that has limited discretionary spending capacity. This helped business thrive even as the economy deteriorated. Although Wal-Mart Stores (NYSE: WMT) competes in this space, GME is the dominant player in the used game business.

The video game industry has expanded due to evolving technologies and widening demographic appeal. Video games have long been popular with males aged 14-49. However, females now account for about 40% of the gaming population, and one-fourth of American gamers are older than 50.

In addition to more robust audio and visual capabilities, modern [video game] platforms offer greater functionality. They play movies and music, and they connect to the Internet.

Thanks to new stores, fiscal fourth-quarter (ending TK) net sales climbed 0.9% year over year to $3.52 billion. However, same-store sales fell 7.9% as hardware manufacturers slashed prices. New hardware sales fell 9.2% to $737.9 million, but new software sales grew 5.2% to $1.56 billion thanks to the release of several popular games. Used product sales grew 8.8% to $777.1 million.

Thanks to a more favorable sales mix, the gross profit margin widened 77 basis points to 24.8%. Even so, operating profit margin shrank to 9.86% and net income declined 7.1% to $215.9 million or $1.29 per share.

Investment risks include weak consumer spending trends and the rising popularity of online gaming. Downloadable content perpetuated by high-speed Internet connectivity could reduce the relevance of retail stores.

Nonetheless, we believe the company’s business model will dominate the market for some time. We are also encouraged by GME’s efforts to explore alternative gaming channels. In November 2009, the company acquired a majority stake in Jolt Online Gaming, a developer of web-based games.

GME [has] 4,429 stores in the US; 1,296 in Europe; 388 in Australia and New Zealand, and 337 in Canada. [It]  plans to open 400 new stores this year and projects sales growth of 4% to 6%.

Same-store sales are expected to rise 0-2% as hardware manufacturers continue to slash prices.   However, thanks to a more favorable sales mix, earnings per share should jump 14%-18%. (The stock closed just below $24 Wednesday—Editor.)

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