GameStop (NYSE: GME) doesn't have many fans on Wall Street these days. The specialty retailer's stock is down by almost a third in the past 12 months. And despite a massive 7% dividend yield, shares are valued at just six times trailing earnings compared to the 24 P/E ratio for the broad market.
The company has a chance to change its narrative with the second quarter earnings results due out on Thursday, Aug. 24. Here are the key trends investors will be watching in that report.
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Focusing on the right business segments
GameStop's big-picture strategy is to control the decline of its core video game business while nurturing new product lines, hopefully filling the void left by customers as they gravitate toward digital game purchases. The company was surprised by the intensity of that shift last year, as comparable-store sales slumped by 11% compared to gains of between 3% and 4% in each of the prior three years.
The key holiday-shopping period hit GameStop especially hard. Revenue tanked 14% in the fiscal fourth quarter as big spikes in its consumer tech and collectibles segments couldn't offset crashing video game hardware and software sales.
GameStop bounced back to slight sales growth in the first quarter thanks to a 25% bump in the hardware business that was powered by the hit Nintendo Switch launch. Investors this week will be looking for solid gains in new business lines, in addition to evidence that CEO Paul Raines and his executive team have a better understanding of the trends that are pinching the physical video game retail industry.
Profit growth as the business shifts
The retailer is becoming more profitable as it shifts the business further toward consumer tech and cellular services. In fact, it generated higher gross profit last year despite an 8% drop in revenue.
GameStop's consumer tech division is easily its most profitable segment, and so management was happy to see the unit expand to 10% of sales last quarter from 8% in the prior year. That success again allowed gross margin to rise even as GameStop endured weakening demand in its new and pre-owned video game segments that still account for over half of the business.
Management recently ended its practice of issuing quarterly profit forecasts, but the company's full-year outlook targets earnings between $3.10 and $3.40 per share. The top-end of that range would mark flat results against the prior year, while the lower end implies a second straight year of declines on the bottom line.
Cash flows staying strong
GameStop's 7% dividend makes it one of the most generous income payers on the market. But unlike many companies with above-average yields, this one is well-covered by both earnings and cash. Its payout ratio is below 50% of profits, after all. Its $150 million annual dividend commitment, meanwhile, amounts to less than one-third of operating cash flow. It would take a string of surprisingly weak results before that payout is threatened.
Management can't do much about the fact that the market they dominate, traditional video game discs, is shrinking. GameStop does have control over which complementary segments it chooses to target, though, and how much it aims to spends in the process.
There's no doubt that the company is in a tough position right now, pinched both by a general slowdown in the retail industry and the digital disruption of its core gaming revenue. The next few quarterly reports will show whether management's plan to transition into new opportunities can occur without too great of a shock to the business.
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Demitrios Kalogeropoulos owns shares of GameStop. The Motley Fool owns shares of GameStop and has the following options: short October 2017 $22 calls on GameStop. The Motley Fool has a disclosure policy.