GameStop (NYSE:GME) is slowly making progress with its financial health. This can be seen in its latest financial results released on Sept. 8 for the quarter ending July 31. As a result, GME stock is slowly starting to rise based on its long-term outlook. This includes a slow but steady improvement in its free cash flow (FCF).
In the last two months, GME rose almost 18% (17.6%) from a low of $146.80 on Aug. 4 to $172.68 as of Oct. 8. However, the stock peaked on June 9 at $302.56 and has since drifted down.
In fact, GME stock seems to be trading in a range between $150 and $218 per share for the past three months. The near-18% rise could be from a realization that GameStop is on a path to an improved financial outlook.
Where Things Stand With GME Stock
GameStop reported that its sales in Q2 rose almost 25.6% to $1.18 billion. However, this was slightly lower than in Q1 when sales were $1.27 billion for the quarter ending May 1.
In addition, GameStop produced an adjusted net loss of $55 million, vs. an adj. net loss last year of $92 million last year. However, that improvement is overshadowed by the much lower net loss in Q1 of just $29.4 million.
In other words, the company is making progress year-over-year (YoY) but not on a cumulative quarterly basis. At least this is how it looks according to standard GAAP accounting.
Free Cash Flow Improvement in Q2
I don’t spend much time analyzing net income and EBITDA (earnings before interest, taxes, depreciation and amortization) these days. These accounting constructs now have many non-cash charges that almost every company removes in their non-GAAP “adjusted” reformulations.
I focus instead on cash flow and more specifically free cash flow (FCF). This is the amount of actual cash that the company generates on a quarterly basis. It includes several items not included in GAAP accounting for net income or even EBITDA or even “adjusted” calculations. It gives a real clear view of the abilities of the company to pay its bills and generate actual cash from its business.
For example, the Consolidated Statement of Cash Flows in the Q2 earnings release shows that GameStop had an $11.5 million outflow in operating cash flow for Q2. This was much better than the $18.8 million negative operating cash flow in Q1.
However, that is not the full story. Free cash flow takes operating cash flow and deducts capital expenditures (“capex”) spending that is necessary for the business. It typically is described in Cash Flow statements as “Purchase of property, plant and equipment.” It is also an example of a type of cash spending that is not included in either net income or even EBITDA.
Therefore in Q2, since the capex spend was $13.5 million, the total FCF figure was negative $25 million (i.e., -$11.50 million – $13.50 million= -$25 million). This, again, was much better than the Q1 FCF figure of negative $33.5 million (i.e., -$18.80 million – $14.70 million = -$33.50 million). In other words, during Q2 the FCF loss was lower by $8.5 million compared to Q1.
That improvement in Q2 over Q1 FCF may not seem like much, but here is why that is important. Operating cash flow will tend to improve with higher sales. In addition, capex spending tends to stay reasonably level or rise slowly. As a result, with higher sales, GameStop’s FCF will improve much more quickly.
Where This Leaves GME Stock
When GameStop reports its fiscal third-quarter results for the period ending Oct. 31, analysts like me will be looking carefully at the Cash Flow statement. We want to see evidence that the company is improving its negative cash burn, and hopefully soon, turning FCF positive.
For example, if there is improvement in Q3 over Q2 with FCF cash losses, then we know that GameStop is on a trend. In other words, one full quarter of FCF improvement is not yet a trend we can completely hang our hat on. But, as I pointed out, with higher sales, most companies will tend to show improved FCF.
At that point, we can more confidently predict where the GME stock might head. If the company can keep lowering its costs, FCF will rise and its valuation could rise. I don’t want to speculate yet what I think the upside could be until the Q3 results confirm or deny this improving FCF trend.
On the date of publication, Mark R. Hake did not hold any position in any of the securities mentioned (directly or indirectly) in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
