Gamestop (GME): Fundamentally Sound Company w/ Huge Growth Potential

James | Aug 05, 2009 | Comments View Comments

Gamestop is a company to reckon with and a stock poised to surge in the coming months. Gamestop (GME) is the world’s largest specialty retailer of new and used video games hardware, software, and accessories. Gamestop is priced currently at $22.86 vastly undervalued. People have their doubts saying that the recession will continue to hold this stock back, fear of new competition will slow it down, and weak consumer spending habits will not allow it to come back. I disagree and think that this stock is poised to take off and this is why:

What Gamestop Does Right

Gamestop has shown strength and perseverance fighting through one of the worst recessions and generated solid operating numbers. Since 2003, Gamestop has grown earnings 31% a year. This included a 36% growth rate throughout 2008 when many were failing due to the recession. Gamestop is expected to grow even more as analysts expect revenues to rise 10% in 2010. It has a current PE ratio of 9, which makes it attractive when compared to its historical normal PE ration of 19. Gamestop continues to generate large amounts of cash, which has allowed them to fund their growth without issuing any debt. No matter what anyone says, Cash is always King! Gamestop’s management agrees with this statement, as they have stayed committed to staying in a good capital position. To add to this they have leveraged their strong flow of cash to continue their global growth through new store openings and acquisitions. Will get into this more detailed later. Adding to this Gamestop bodes significant assets to lure in new customers compared to competition. Gamestop’s publication, Gamer Informer is the Wall Street Journal of video game information for serious gamers. This paid publication offer tips, game reviews, etc to over 2.2 million subscribers. Worldwide we are also seeing an increase in video game users and a change in the demographics. Once dominated by men and teens this industry has shifted as now a days near half of all gamers are both female and over the age of 30. To read more into this and the future of Gaming, check out yesterday’s article. Gamestop works very hard to keep serving its dedicated consumer pace by offering many extras such as tournaments, gamer communities, etc. This has proven to be successful, as they have built a formidable brand similar to Apple where customers continue to stay loyal. Gamestop has taken advantage of the lucrative used games business. Gamestop has created large facilities to refurbish, clean, and repair games and then resell them on the open market. It has taken 12 years for this to people a profitable aspect of their business plan so it has created a challenge for competitors to compete with. I expect the used game business to continue to thrive in 2009 and beyond especially during the challenging economic environment. We saw it jump 32% in the first quarter of the year, so no reason to doubt it will keep up similar success in the 2^nd half of the fiscal year.

Growth by Numbers

I believe competition should not be a concern for Gamestop. Companies like Amazon, Wal-Mart, and Best-Buy are greatly overblown when compared to the success Gamestop has achieved. In fact, the competition should be worried about Gamestop. Recently, Gamestop purchased Micromania, France’s largest video game retailer with over 300 stores. This was a strategic move as before that Gamestop had little presence within France. Strengthening their presence within Europe and abroad Gamestop bought Free Record Shops in Norway and The Gamesman in Australia and New Zealand. These acquisitions give Gamestop a larger presence internationally, which has been a thriving market for the video gaming industry. It is reported that in 2009, the video game industry will become the largest Entertainment Medium in the United Kingdom. Currently, Gamestop controls 6,200 stores worldwide. This includes the control of EB Games. To add to this expanded growth, Gamestop plans to open 400 new stores worldwide and expand its online store in 2009. This will help solidify, Gamestop’s emergence as the world’s largest video game retailer.

What Growth Potential Does Gamestop Have

I believe Gamestop has strong short-term growth and long-term opportunities as we enter into the 2^nd half of 2009. As I mentioned in yesterday’s article the video game industry should expand in the second half of 2009 due to the release of Blockbuster titles such as: Madden NFL 10, Call of Duty: Modern Warfare 2, Assassin’s Creed 2, Left 4 Dead, The Beatles Rock Band, Halo 3, Guitar Hero 5, etc. This will greatly increase the revenue from new-software sales for Gamestop, which was down 2% in the first quarter. Plus leading into the Christmas shopping season, retailers and video games always become a hot commodity. Long-term the expansion of their global brand along with an emergence in second generation systems will help future sales growth. Adding to this is the 10% annual expected growth in the industry as a whole along with the expansion of the customer demographics adding more potential consumers. I believe the video game market is far from saturated leading Gamestop to potentially run and operate more than 7,000 stores worldwide. Despite the slowdown in Consumer spending I expect Gamestop to continue to produce growth in overall earnings and revenue. I think Gamestop will capitalize on the growth of the video game industry, expand in the used game market, and increase awareness of the Gamestop brand.

Overall Valuation

Gamestop is currently trading at $22.86, which is vastly undervalued and has positioned the retailer to outperform the market within the next 12 months and beyond. EPS numbers are expected to increase 17% leading into 2010 showing a solid line of growth. To add to this the balance sheet is a compelling attraction with little debt and a high cash flow. PE ratio is trailing very low right now at 9. Basic assumptions project that this number will return to its normalized standing around 16. A double in today’s number is a reasonable expectation and a great growth prospect. Gamestop’s PEG Ratio is 0.49, which is very enticing as I value quality companies to have a PEG below 1. International growth will continue due to large acquisitions mentioned earlier. Used video games sales will continue to thrive along with new releases due to the blockbuster titles coming out this fall. Long term, Gamestop is a great pick as a growth stock with high potential. Based upon my valuations I foresee Gamestop reaching $35 12-months from now a total gain of around 60%.