3 Surprises From GameStop's Earnings Report

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Investors had good reason to expect bleak results in GameStop's (NYSE: GME) third-quarter earnings report. After all, its stores are exposed to the weak customer traffic trends that are hurting the wider retailing industry. Video game publishers are also using digital sales platforms to disrupt its lucrative buy-sell-trade business.

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Put it all together and worries over a retreating business contributed to a 30% loss for the stock this year as GameStop's dividend yield climbed above 9%.

This week's earnings announcement, however, was highlighted by mostly good news, including improving sales trends in the core video game segment. Let's take a closer look.

Steady gaming growth

GameStop's video game division posted surprisingly steady growth. Comparable-store sales rose 2% to mark the third consecutive quarter of gains. Sure, that's below the 3% to 4% that GameStop managed in the three years ending in 2015. But that sales pace puts it in a good position to improve on last year's 11% comps drop.

The growth was uneven, though. GameStop saw big gains in its new video game hardware segment mainly thanks to the popularity of Nintendo's new console. New software sales were also healthy, while the preowned game segment shrank slightly.

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GameStop generates far higher profit margins on used games than it does by selling new titles. Its console sales, meanwhile, are its least profitable division. Thus, the shifting sales mix resulted in a slip in overall profitability as gross margin fell to 34.1% of sales from 36.1% a year ago.

Tech brands weakness

While the device release calendar helped power growth in the video game segment, it led to a slump in GameStop's consumer tech division. Executives said delayed access to Apple's new generation of iPhones played the biggest role in the tech brands unit enduring a 10% sales slump after the 7% increase from the prior quarter. That contraction was just partially offset by booming growth in GameStop's smaller collectibles segment, which grew 27% and is on pace to meet management's target of between $650 million and $700 million of sales this year.

Executives had predicted that the tech brands division would achieve $120 million of operating earnings this year compared to $90 million in 2016. That goal now mainly depends on how much supply GameStop can secure of Apple's iPhone X over the coming weeks.

Brightening outlook

The outlook for the core video game segment isn't as cloudy. In fact, GameStop is confident that excitement around a new Xbox One console release, plus several blockbuster video game title launches, will produce accelerated sales growth over the holiday season.

As a result, the company raised its 2017 comps outlook for the second time this year. After initially targeting a 2.5% decrease, the forecast crept up to a flat sales result in the second quarter before rising to a range of between low- and mid-single digit increases today.

The earnings forecast held steady at between $3.10 and $3.40 per share. Either end of that range would translate into healthy protection for the company's generous 9% dividend yield, given that its payout commitment is only $1.52 per share.

GameStop has only generated $1.39 per share of profits (less than half of its full year target) through the first three quarters of the year. That goes to show just how much the retailer depends on the holiday season for most of its revenue and earnings.

On the one hand, risk-averse investors could see that intense seasonality as a good reason to stay away from this stock at least until the fourth-quarter results confirm that the business isn't in retreat. If you're impressed that GameStop is largely meeting its financial and operating targets, on the other hand, you might consider buying this retailer while Wall Street remains pessimistic about its outlook.

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Demitrios Kalogeropoulos owns shares of Apple and GameStop. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of GameStop and has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and short January 2018 $19 calls on GameStop. The Motley Fool has a disclosure policy.