Meme-stock investors bowed at the feet of its god yesterday. But, of course, I’m speaking about GameStop (GME), the video game retailer-turned-collectibles and cryptocurrency purveyor. The company turned its first quarterly profit in two years.
As a result, GME share and options volume was off the charts Wednesday. The stock gained over 35% with a volume of nearly 67 million, 10x its 30-day average. Regarding options, 697,178 contracts traded hands yesterday, 7x the average daily volume.
There is no question that meme-stock investors loved yesterday’s news. However, if you’re a serious long-term investor, you shouldn’t let yesterday’s unusual options activity and overall share volume cloud your judgment. Here’s why.
The Profit That Was
Analysts were expecting a 16-cent loss. Instead, GameStop delivered a 16-cent profit. It’s hard not to celebrate such a big earnings beat, but one should consider how and why analysts might have missed this one regarding the income statement. For what it’s worth, analysts were a bit closer on revenue estimates. Wall Street called for $2.18 billion in revenue. GameStop delivered $40 million above that.
The company talked a big game in its Q4 2022 post-earnings conference call.
CEO Matt Furlong discussed the company’s proactive steps in 2022 to meet a changed operating environment “due to the onset of inflation, rising interest rates and material macro headwinds,” Furlong stated in the call.
“Rather than standstill, we pivoted last year to cut costs, optimize inventory and focus on enhancing the customer experience. We found efficient ways to improve shipping times, integrate online and in-store shopping experiences and establish a culture of increased incentivization amongst store leaders and tenured associates,” Furlong said.
It all sounds great, but how much of it is verifiable by investors?
You can point to lower operating expenses on the income statement to confirm the cost cuts. GameStop’s selling, general and administrative costs were 16% lower year-over-year. You can also verify inventory optimization by looking at the balance sheet. Inventories fell by $232.1 million YOY.
But the claims of creating a better omnichannel experience through some zen-like focus are tough to confirm without actual data. Indeed, revenues weren’t higher as a result.
Wedbush Securities analyst Michael Pachter pointed out in post-earnings comments that the company’s gross margin at 22.5%, albeit 570 basis points higher than Q4 2021, was well below GameStop’s historical average of 24% to 29%.
“It's unlikely that they can grow by spending less. I expect them to return to losses again next quarter, and think this is a one-off result,” Reuters reported Pachter’s comments.
In the end, GameStop’s fundamental task is to re-ignite top-line growth. Unfortunately, it’s yet to do that. As recently as fiscal 2015 (Jan. 2016 year-end), GameStop had $9.3 billion in revenue. It was $5.93 billion in 2022.
The Collectibles Were 16% of Revenue
In 2022, the company generated $965 million in Collectibles revenue, accounting for 16.3% overall. That’s up 260 basis points from a year ago. Software accounted for less of its overall revenue in 2022 (30.7% vs. 33.5%), while Hardware and Accessories had a little bump, from 52.7% in 2021 to 55.8% in 2022.
So, you can take three things from the above paragraph:
1) Its software business is going backward. In a digital age, that’s not good.
2) Due to software going backward, hardware became a bigger part of its business in 2022. The whole reason GameStop went to this game plan was to get away from in-store hardware, etc.
3) Collectibles are the growth vehicle. Revenues grew 17% YOY.
Is that enough growth to justify a P/S ratio of 1.23x? The only time it’s been this high in the past decade was in the crazy meme-stock era of 2021 when its multiple was a nosebleed of 1.77x.
When you consider that GME had a P/S ratio of 0.66x in fiscal 2015, a year in which it had $9.3 billion in revenue and $660 million in operating income, both considerably higher than the company’s 2022 results, it makes no sense to be trading over 1.0x sales.
None.
Wednesday’s Unusual Options Activity Points to Positive Free Cash Flow
As my Barchart.com colleague, Mark Hake, pointed out Wednesday, the good news for GameStop investors was that it generated a positive free cash flow of $52.3 million in 2022, up from a negative free cash flow of nearly $500 million in 2021.
As a result, the company’s cash burn has stopped--at least for now. However, once the brain trust at GameStop realizes that you can’t continue to cut and expect revenues from all three segments to grow, the cash burn will reignite.
Hake believes this explains yesterday’s unusually active options activity. Specifically, put options expiring tomorrow and a week later. They provide good short-term yield opportunities, given the company has turned free cash flow positive.
Better choices were available yesterday if you want to own GME using options.
One that stands out for me is the April 21 $16.50 put. You sell that for $29 income. Repeat that 12 times, and you’ve got a 21% annual return. At the same time, if the share price falls to $16.50 and it’s put to you, it’s a cheaper buy than what you would pay today. Of course, you’ve got to like its long-term prospects.
I don’t.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
