GameStop (NASDAQ:GME) stock has been on another turbulent ride. The company share price trended higher by 10.4% following its first quarter earnings release, despite widening losses. Investors cheered on a decent growth in revenues.
I believe that GME stock price does not support its fundamentals. No doubt, it’s one of the most popular meme gaming stocks on the Wall Street.
The company sells new or used gaming products through its chain of stores in the United States, Canada, Australia, and Europe. However, demand from this business model is fading away given the ease to download and play games online.
As such, large institutional investors have been shorting the stock for some time now. The company’s short interest as a percentage of float was 23.2% as of May 30, 2022.
| GME | GameStop | $142.02 |
Back in January 2021, a group of investors on Reddit pushed the stock price higher. That was around the peak of meme and penny stock euphoria.
The price moves certainly benefitted the company. GameStop raised enough capital to pay off its debts throughout 2021. GameStop still has more than a billion dollars to support its business needs.
I believe a stock price correction is likely as its fundamentals remain weak.
Profits are burning down
Within a span of one year, the company’s cash flow has turned negative and profitability declined despite a modest growth in revenues.
Adjusted operating profits of $62.3 million in FY 2019 turned to a loss of $238.0 million in FY 2020 and $336.6 million in FY 2021. In fiscal Q1 2022, adjusted operating loss amounted to $160 million or a margin of 11.1%, 796 basis points (bps) higher than the last year.
Shift in product mix towards lower margin categories has been the primary reason for compressed margin growth. Other reasons include higher freight and credit card fees, and costs associated with transformation into an ecommerce company.
Total cash flow from operations turned from a positive $123.7 million in FY 2020 to -$434.3 million in FY 2021 and -$303.9 million in Q1 2022.
Going forward, the company’s ability to drive future profitability would only sustain its business. GME is launching digital wallet by July 2022 to support its software sales. The digital wallets shall allow its gamers to use cryptocurrencies and non-fungible tokens to transact online. Although the move appears promising, its adoption among masses is highly uncertain.
Concluding Views
In the Q1 2022, total video game spending in the US dropped 8% led by a declined across all the segments: games (-7%), hardware (-15%) and accessories (-16%). Although the numbers are ahead of pre-pandemic levels, the time spent on gaming is dropping. With the broader industry segment experiencing sluggishness, the outlook is negative.
Currently, the company’s cash of $1 billion should support its near-term obligations. However, going forward, GameStop might need to dilute equities further or resort to debt financing.
Given this scenario, current valuation of 1.45x trailing twelve months sales versus peer group average of 0.83x appears lofty. I would not suggest an investor to take this speculative bet.
On the date of publication, Sakshi Agarwalla did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.