As if the Blockbuster comparisons weren’t enough, investors were given another reason to avoid shares of GameStop (NYSE:GME) for the foreseeable future: a messy fourth-quarter earnings report and ugly fiscal 2019 guide, which together imply that the worst is far from over for the struggling video game retailer.
Everywhere you look, GameStop’s Q4 earnings report was a disaster. New hardware sales dropped sharply. So did new software sales. The pre-owned business saw its revenues drop over 20%. Gross margins compressed meaningfully. Profits fell dramatically. The guide called for the slowdown to only get worse next year.
Overall, it was a bad report. Shares of GameStop dropped sharply in response. As of this writing, GME stock trades at fresh decade lows, and is below the $10 level for the first time since 2005.
The unfortunate reality here is that the GameStop turnaround isn’t going to happen anytime soon, or maybe ever. In the near term, there’s a bunch of warning signs, such as a lack of new titles and console catalysts in 2019, alongside continued weak hardware and software numbers, all of which imply that earnings are far from bottoming. In the long term, the challenges are only growing. Namely, cloud gaming is finally becoming a reality, and it’s only a matter of time before cloud gaming platforms like Google Stadia go mainstream. Once they do, that could cement Gamestop’s destiny as the next Blockbuster.
All in all, there’s little reason to buy this dip in GME stock. It may bounce back in the near term. But, that recovery will just be a head fake that will ultimately be faded. In the big picture, there are too many concerns here to warrant sustainable gains in GME stock. Lower for longer is the most likely path forward.
GameStop Continues to Struggle
Although the challenges to GameStop are well known — the company could easily be ousted from the video game market, like Blockbuster was ousted of the movie market, by streaming platforms — it seems that the whole market has been waiting for this hypothetical big turnaround in GameStop for the past five years.
In early 2016, there were murmurs that the decline was over and that GME stock would turnaround at $25. That didn’t happen. The stock bounced, reversed course and ultimately dropped far below $25. Same thing happened in late 2016 at $20, in late 2017 at $15 and in mid-2018 at $13. Time and time again, bulls get excited about the prospects of a GameStop turnaround, led by some new hypothetical catalyst, such as “the new phone business will turn things around” or “new consoles will boost the hardware business”. GME stock gets some upward momentum on that catalyst. But, this catalyst is never enough to offset secular headwinds. The upward momentum is consequently short-circuited by continued bad numbers, and the stock ultimately resumes its longer-term selloff.
The more this happens, the more it becomes clear that a turnaround isn’t coming. We are already five-plus years into a secular decline in GameStop’s business, and not only are the numbers about as bad as ever, but they are also only going to get worse. Comparable sales were essentially flat this year. They are supposed to drop ~7.5% next year.
Thus, at this point in time, the most likely outcome for GameStop is becoming the next Blockbuster. After all, why wouldn’t it be? What is the difference between the physical video game and DVD businesses? They are nearly identical industries. Thus, the video game market will respond to streaming disruption in the same way the DVD market did — physical sales extinction.
Lower for Longer
To be sure, GameStop will be able to make a ton of money on its way to extinction. Cloud gaming is still a long ways from becoming the mainstream norm, meaning that there is still a long and healthy runway for GameStop to sell a bunch of consoles and physical video games over the next several years.
But, that won’t be enough to warrant gains in GME stock.
The reality is that investors don’t like to buy into stocks when revenues and earnings are in free fall. That’s exactly what is happening at GameStop right now. GameStop’s revenues and earnings are in free fall. They have been for a long time, and the fiscal 2019 guide implies that they will continue to be in free fall for the foreseeable future. So long as earnings aren’t showing any signs of bottoming, GME stock won’t bottom, either, since investors have no clarity as to what profits tomorrow will look like.
Consequently, lower for longer is what should be expected from GME stock. You may get a little bounce in the stock here, like you have following many of the steep selloffs this stock has seen over the past several years. But, much like those other bounce backs, this one won’t be sustained. No rally in GME stock will be sustained until earnings bottom.
Bottom Line on GME Stock
As much as I want to believe in the GameStop turnaround (I’m a sucker for a good underdog story), it is becoming increasingly apparent that this company is going the way of Blockbuster. As such, until earnings bottom and give fundamentally supported hope for a turnaround, GME stock should be avoided.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
