Description

GameStop Corp. (NYSE:GME) is a video game retailer. The Company distributes video game hardware, physical and digital video game software, video game accessories, as well as mobile, consumer electronics and other merchandise through its stores. The Company’s segments consist of retail operations, engaged in the sale of new and pre-owned video game systems, software and accessories. The stores sell various types of digital products, including downloadable content, network points cards, prepaid digital, prepaid subscription cards and digitally downloadable software and also sells mobile and consumer electronics and collectible products. Its Technology Brands segment includes its Spring Mobile and Simply Mac businesses.

Source: Thomson Reuters

Investment Rationale

GME reported positive Q3 earnings, with EPS of USD0.54, beating consensus estimates of USD0.43. Revenue was also 1.5% higher YoY, coming in at USD1.99bn, beating consensus estimates by USD30mn. GME cited stronger same-store sales growth as well as strong demand for the Nintendo Switch as reasons for the positive earnings. As stated in our previous trading note on GME, we believe that while GME is facing headwinds in its core product line, it has been unfairly punished and there are several positive catalysts for the stock on the horizon.

Recent Price Action: Since our previous Trading Note on GME, the stock had hit out target price of USD23.96 before tumbling below our stop loss of USD19.95. The stock then fell further to its 52-week low of USD15.85 and has since recovered to its last done price of USD16.73 on the back of its positive Q3 results.

Video game Hardware Sales: The current generation of hardware consoles, the PS4 and the XBox One, arrived close to 4 years ago in November 2013. This coincided with a huge run up in GME share price prior to the release of the consoles. With the release of the Nintendo Switch in March 2017, and its massive popularity, we believe that this might signal a new cycle for Video game Hardware, which GME might benefit from. GME reported that New Videogame Hardware sales came in at USD309.5mn for the quarter, up 8.8% YoY, on the back of strong demand for the Switch. As of end October, Nintendo reported that the Switch had sold more than 7.6mn units and had increased their expectations for the console, expecting it to sell 14mn units, up from initial estimates of 10mn, in its first year.

Strong Console sales also equate strong game sales, as consumers buy the games to play on their consoles. GME reported new Video game software sales came in at USD649.9mn, up 5.4% YoY. High demand for the Switch’s line up of games help drive GME software sales. Legend of Zelda: Breath of the Wild, sold more than 4.7mn copies since release, and Super Mario Odyssey, which released on 27 October, has already sold more than 2mn copies.

Additionally, Microsoft recently released its update to the Xbox One, the Xbox One X, on 7 November. Early numbers for the console has been very positive, with UK numbers coming in at 80,000 units in its first week. The PS4 Pro, Sony’s equivalent, took 4 weeks to hit that figure.

With the holiday season coming, we believe that Hardware and Software numbers should continue to boost GME’s sales.

Transitions: GME has not been sitting idly while their core market segments are being eroded. With the acquisition of ThinkGeek, GME has reported strong results for its collectible segment, with an increase YoY of 26.5% to USD138.4mn. GME also expected collectibles to grow 30% to 40% in FY17. GME mentioned that they are shifting their in-store product mix to be 50-50 games and collectibles, which should help boost collectible growth.

GME is also attempting to adapt to the trend of digital downloads for games by branching out as a game publisher, launching GameTrust last year to publish indie games. GME mentioned that digital sales increased 11.9% YoY, though on a reported basis the sales declined to 16.8%, Non-GAAP digital sales increased 1.8%, due to the sale of Kongregate, a mobile game developer.

Valuations:  GME closed at USD16.73 and trades at a PER of 5.03, with a dividend yield of 9.09%. GME has total debt of USD816mn, with USD262mn in Cash and equivalents. GME’s annual net income has also been relatively consistent despite headwinds, at USD353mn in FY16 and USD402mn in FY15. GME also pays a very high dividend, yielding 9.09%. This amounts to an annual payout of about USD155mn. GME is expected to generate more than USD400mn in Free Cash Flow, and even its worst year in the past 5 years, GME managed to generate USD300mn in Free Cash Flow. GME’s high yield dividend is very well covered and should not be in any danger of cuts despite the fears over its business. As such, we believe that GME is very much undervalued at this price despite the headwinds they are facing.

Technicals: GME continued to move in a long-term downtrend with sharp rebounds occurring along the way when the Relative Strength Index (RSI) signals oversold condition. RSI measures momentum and a reading below 30 suggests oversold condition. This oversold RSI mean reversion pattern has been working perfectly since January 2016 where GME experienced five of such price action pattern. On average, the rebound off the respective lows was around 17%.

GME Daily chart – Mean reversion higher next due to the oversold RSI

Support 1: 16.00                  Resistance 1: 18.47

Support 2: 15.32                  Resistance 2: 20.00

Red line = 20 period moving average, blue line = 60 period moving average, Green line  = 200 period moving average

Since the last update on 7 April 2017, GME continued to move in a general downtrend. It gapped down significantly on 25 August 2017 and subsequently took the RSI into oversold condition. The RSI hit a low of 29 on 31 August 2017, and once the RSI closed back above 30 the following day, the mean reversion pattern took over, and GME rebounded sharply up 11%.

Even after the recent mean reversion since August, the rebound in price appeared short-lived. The 20 and 60-day moving average once again capped the bullish recovery in GME where the long-term downtrend retook control. The downtrend managed to bring price down to break a new 52 week-low, and as a result, the RSI entered into the critical oversold region since 3 November 17.

With the mean reversion pattern still fresh in mind, the recent price action suggests a possible bottoming process. GME began consolidating around the 16.00 range as the RSI dipped below the 30 oversold region. On 21 November 17, a more decisive bullish price action appeared. There was an increasing volume bullish bar that succeeded in lifting the RSI back above the 30 oversold region. That price action validates the mean reversion pattern is happening where a rebound higher to the 18.47 resistance area followed by 20.00 is expected.

Bear in mind a stronger support area lurks in the background suggests limited downside. The 2012 low of 15.32 should keep a floor on the share price in the short run.

Conclusion: We are bullish on GME due to 1) New Hardware sales, 2) Transition plan and 3) Strong financials and dividend yield. As such, we believe that stock is undervalued and with recent signs of recovery, we are bullish.