GameStop (NYSE:GME) sells gaming discs in physical stores that no one is going to anymore. Kids can just as easily rent or buy them online. So why is GME stock trading so high?
The stock has been on a roller coaster as of late. At the end of December 2020, GME stock was at $18.84. Suddenly it popped to $347.51 as of Jan. 27. By Feb. 19, it was back down to $40.59. Now, as of the close April 19, it is back up to $164.37.
At that price, the GME stock, which had just $5.1 billion in sales in 2020, has a market capitalization of $10.82 billion. Instead of 2 times sales, most retail stocks trade for 30% to 50% of sales. Clearly, something different is going on with GME stock. It is trying to reform or rejuvenate itself. Nevertheless, the stock still looks to be too expensive, given its present cash flow situation.
A New Chairman and a New Perception
Since the beginning of April, GameStop has had a new chairman, (actually he takes over at the company’s upcoming annual meeting). Ryan Cohen, the co-founder, and former chief executive of online pet food company Chewy (NYSE:CHWY), joined the GameStop board in January and has been shaking things up there since then.
He has gotten rid of most of the upper management, including CEO George Sherman, and has effectively acted to replace most of the board. In short, he wants to pivot the company from a brick-and-mortar video game retailer to an e-commerce firm.
Turnaround and E-Commerce Hopes
That is going to take a lot of work. At the end of 2020, GameStop had 4,816 stores, including 253 in Canada, 954 in Europe, and 417 in Australia, according to page 1 of its 10-K report.
That is a lot of stores that it wants to “de-densify” out of its global store base. It could easily take several years. For example, last year the company rid itself of just 693 stores or about 12.6%. At that rate, it will take over five years even if it got down to a 20% base from today’s number.
In the meantime, the company’s online sales account for a small percentage of its overall sales. As with many retailers, GameStop is very coy about its actual e-commerce sales. Nowhere will they state the actual dollar amount, either in their press releases or in their 10-K or quarterly filing. However, they are very quick to point out that e-commerce sales rose 175% in Q4, and 191% in 2020.
This high growth rate implies that the actual online sales amount is very low, probably no more than 10% to 15% of total sales. Some analysts are doubtful of GameStop’s turnaround plan to turn around e-commerce sales, especially given its negative comp store sales last year. Jefferies, which was hired as an investment banker for GameStop, assumes an upside scenario of a 50% transfer of sales to online from bricks and mortar. That is a very rosy scenario and could take many years to occur. Moreover, it also assumes the loss of 50% of total sales now.
Where This Leaves GME Stock Now
The truth is the company made just $63.7 million in free cash flow (FCF) last year, according to its own press release. That amounts to a paltry FCF margin of just 1.25% of its $5.1 billion in sales. Even if we assume that the Christmas season FCF of $137.4 million lasts for the whole year (which is FCF neutral), it still amounts to just 2.7% of sales. This is a really low figure.
Granted, if somehow the company can get to 50% of sales online, the FCF level will rise. Let’s say it can double to a margin of, say, 6% of sales. In addition, sales would be lower by 50%. That would amount to 6% of $2.5 billion, or $150 million in FCF.
Today’s valuation of $10.8 billion is still too high. That implies that even with a major turnaround (no guarantee this will happen), GME stock trades at an FCF yield of 1.39%. Another way to put this is that the market value is 72.1 times its FCF.
A more reasonable figure is 36 times FCF, implying a 2.77% FCF yield or 36 times FCF. GME stock is not worth more than $5.4 billion (i.e, 36 times $150 million). This is 50% of its $10.8 billion market cap. GME stock is not worth more than 50% of $164.37, its Monday closing price, or $82.19.
Most will want a 33% discount, or $54.79. for a 50% ROI. It is also one-third of today’s price.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article.