On April 17, Bespoke Investment Group came out with a list of the most heavily shorted stocks in the S&P 1500. To qualify, a company had to have at least 25% of its freely floated shares sold short.
Topping the list at 53.1% is Diamond Foods (NASDAQ:DMND), the California-based snack-food company that crashed and burned earlier this year due to accounting malpractice and a botched deal to buy Pringles from Procter & Gamble (NYSE:PG). It’s so beaten down, it’s a tempting buy. I’ll pass, however, and recommend instead these three favorites of the shorts that I believe are buys.
Let the squeeze begin!
GameStop (NYSE:GME) has 6,683 stores worldwide. In the last three fiscal years, it spent approximately $516 million opening 1,032 stores. The shorts argue that GME is throwing good money after bad and that eventually it will end up like Blockbuster. They further suggest that GME isn’t investing enough in its digital platform, which is the future of video games. Let’s address those concerns.
In 2011, GME reduced its store footprint in the U.S. by 1% and slowed its international store expansion. In 2012 it expects to open 100 stores in the U.S. while closing 150. Internationally, it will open stores, though square footage will remain flat.
GameStop has become far more selective about where it puts its stores. Convenient locations where customers can buy and sell used video games is a valuable service that helps promote new software, hardware and downloadable content. Not to mention that gross margins on used video games were 46.6% in fiscal 2012 — more than double those for new games. Eliminate physical stores and you can kiss a good portion of those sales goodbye.
As for its digital platform, GME grew digital receipts by 57%, to $453 million, in 2011. By 2014 it expects digital revenues to be $1.5 billion — a 50% compound annual growth rate from 2010 to 2014.
In the span of three fiscal years, it has expanded gross margin of its “other products” category, which includes digital, by 600 basis points, to 39.8%. In three more years, I could see that number being in the mid-40s. If that happens, and GME generates the $1.5 billion in revenue it’s projecting, digital alone will generate gross profits of $675 million.
With GameStop’s financial condition as strong as it’s ever been, I see its transition to online gaming as a profitable one — without sacrificing the chain’s physical presence. The shorts be damned.