Video game retailer GameStop (NYSE: GME) managed to beat analyst estimates for earnings in the first quarter, but the good news ended there. Revenue slumped more than expected; sales of pre-owned and value products, the biggest contributor to the company's gross profit, dropped more than 20%; and the company suspended its dividend, effective immediately, in an effort to shore up the balance sheet.
A double-digit sales decline
GameStop's revenue was $1.55 billion in the first quarter, down 13.3% year over year and $90 million below the average analyst estimate. Comparable-store sales tumbled 10.3% year over year, with weak results in both the U.S. and international markets.
Every product category except collectibles and accessories suffered sales declines in the first quarter:
The continued decline in pre-owned and value video-game sales is the biggest problem for GameStop. This category had a gross margin of 44% in the first quarter, more than double that of new video game software, and it contributed roughly 37% of the company's total gross profit. Used-games sales have been declining for years, and that trend shows no sign of letting up.
GameStop's bottom line was ahead of analyst expectations, but it declined steeply on a year-over-year basis. Adjusted earnings per share were just $0.07, down from $0.30 in the prior-year period. Cost-cutting efforts weren't nearly enough to offset slumping revenue.
I warned two years ago that GameStop's dividend was unlikely to survive. The company announced along with its first-quarter results that it was eliminating its quarterly dividend, effective immediately. The $0.38 per-share payout, good for a dividend yield of nearly 20%, is no more. This move frees up $157 million annually, which will help the company pay down its debt.
It won't get any better this year
GameStop expects comps and total sales to decline by 5% to 10% in fiscal 2019. The company didn't provide earnings guidance, but it did say that it's on track to achieve $100 million of operating profit improvements as part of a plan announced in April. That improvement, though, may end up being swamped by the negative impact of declining sales.
GameStop is facing an existential crisis as game sales go digital, meaning there's no such thing as a used digital game. So this shift is a huge problem for the company's lucrative used-games business. There's no easy solution – cost-cutting may slow down the profit declines, but it won't solve the fundamental problem.
With no dividend, one big reason for owning GameStop stock is gone. And with earnings falling off a cliff, a low P/E doesn't mean much. GameStop stock has looked cheap for years, but it has never actually been cheap.
The next generation of video game consoles, expected to launch in the next couple of years, could give the company a temporary boost. But that won't change the long-term story.
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