GameStop Corp. Lowers Outlook as Video Game Hardware Sales Slump

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Specialty retailer GameStop (NYSE: GME) announced quarterly results this week that reflected a difficult sales environment in its core video game market. Growth accelerated in its emerging business lines such as consumer tech and mobile services. However, that success was overshadowed by a sharply weaker retail gaming division.

Here's how the headline results stacked up against the prior year period:

Data source: GameStop's financial filing. YOY = year over year.

What happened this quarter?

GameStop endured a surprisingly large drop in comparable-store sales, down nearly 11%. CEO Paul Raines and his team had projected a more moderate decline of between 4% and 7% this quarter.

Other highlights of the quarter include:

New video game device sales plunged 35%, which executives blamed on the fact that manufacturers released new details about upcoming console launches, leading many gamers to hold off on making purchases.
New game software fell at a more moderate -- yet still significant -- pace, declining 18% on account of a weaker release calendar compared to last year that included the blockbusters Batman: Arkham Knight and Elder Scrolls Online. The pre-owned side of the business dipped by 3%.
GameStop's mobile and consumer electronics segment grew by 43%, and its collectibles sales more than doubled thanks in part to the Pokemon craze.
Because these new business lines carry much higher profit margins than new video game sales, the retailer's profitability soared. Gross profit margin spiked to 38% of sales from 33%, while operating earnings rose to 4% of sales from 3%, and net margin ticked up to 2% of sales from 1% in the prior year.

What management had to say

CEO Paul Raines indicated that GameStop's diversification strategy is helping the retailer navigate what he described as a difficult quarter for the video gaming industry. "The continued growth and increased profit contribution of our non-physical gaming businesses drove our second quarter results," Raines said. "Tech brands sales grew more than 50%, omni-channel sales increased 16%, collectibles sales more than doubled and year-to-date, more than half ofGameStop'soperating earnings have come from non-physical gaming categories," he explained.

For the full year, executives see tech brands growing at a 55% clip and collectibles sales rising by 45% on their way to a $1 billion annual business by fiscal 2019. Management has no plans to step away from its core market, either. "Physical video gaming is a strong business, and one with a long tail," executives said in an investor presentation.

Looking forward

Thanks to those growing areas of the business, GameStop affirmed its full-year profit outlook that calls for earnings of about $3.97 per share, up 5% from 2015. The retailer's improving profitability and earnings profile continues to be an important bright spot for shareholders, especially income investors who are attracted by its hefty dividend yield that's well supported by profit and cash flow.

There's no question, though, that its core video game market is weak and declining at a faster pace than management had expected. GameStop lowered its sales growth forecast to as much as a 5% drop in comps -- down from the roughly 2% slide it had projected in late May. Meanwhile, the company remains on pace to shift its business, so that more than half of profits are generated by products other than physical video games by 2019.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool has the following options: short October 2016 $28 puts on GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.