Gamestop Strategy Spotlight (GME)

Summary

  • Buy for value below $22.67
  • Buy for momentum now as recent price action looks to be a signal that real money is buying
  • Watch for announcements that hint at changes in growth expectations, potentially buy momentum if growth is revised upward

Potential Alpha

Gamestop is a declining revenue, high volatility stock. It has a market cap of $2.3b and turnover of $60m per day. Because revenues are currently declining its possible that the street extrapolates this negative growth too far creating a value opportunity. A momentum opportunity could also exist if growth expectations suddenly shift. The CFO also recently stated that he would be replacing quarterly guidance with annual guidance. This potentially increases the uncertainty and hence volatility of the stock.

Company Notes

  • Omnichannel video game retailer who’s brands include Gamestop, EB Games

gme revenue breakdown.PNG

  • New video game software and hardware is cyclical depending on timing around new console and game releases
  • Growth is focused on Technology brands (+21%), collectibles (+39%) and digital video games (+3%) which together contribute ~17% of revenue and ~ 37% of operating earningsgme gross margins.PNG
  • Street consensus is that physical video game sales are being replace by digital download which is the accepted explanation for declining new game software/hardware sales and declining comparable store sales
  • Gamestop’s competitive advantage and largest profit contribution with high margin of 48% is their pre-owned products but even this segment is being disrupted by Amazon and others
  • $330m of $500m share buyback completed, last tranch at $25 average price

Valuation

Using a relatively pessimistic assumption around revenue growth of -10% per year we see intrinsic value to be $20, assuming no further increases in operating margin.

gme valuation.PNG

gme grid.PNG

Despite the lower margin hardware and software revenues falling 5-10% (~67% of revenue and profit), higher margin technology brands and collectibles sales are growing at 20%+ (which makes up 16% of revenue and 20% of profit). Averaging those growth figures results in an all-in growth rate of approx -3%. Using the current operating cash flow margin of 6.20% this results in an intrinsic value of $28. Keep in mind the business strategy is to continue switch revenue from the lower margin streams to higher margin streams, so this could also increase over time.

Strategy

gme chart.PNG

 

Our theory is that $20 is an overly pessimistic valuation and an obvious buy for value. If there’s a change in growth expectations we expect to see price move to $28. To maintain a 2:1 payoff ratio we’re buying for value below $22.67.

High quality momentum in this situation is likely to occur after large sellers finish selling and fresh real money starts buying. This seems to have happened recently following earnings releases and large price gaps. The fresh high price after recently lower volatility could also be a signal that real money is stepping in. A possible trade is to buy for momentum now and hold while price remains above the 60day moving average. Perhaps a higher probability setup is to wait for news announcements that hint at a shift in growth rate expectations. Real money is likely to be slower to adapt to this news and could create an excellent momentum opportunity.

Sources

 

One thought on “Gamestop Strategy Spotlight (GME)

  1. Pingback: Value-Momentum Watchlist | Know Your Alpha

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