“GameStop, tough day for them, reporting second quarter profit, down 32%. $39 million was the figure. They had fewer hit video games and a 14% drop in same-store that’s forcing the company to cut its full year outlook. Wall street hates that as you can see by a 7% give back there.” –CNBC’s Closing Bell 8/20/2009

Shares of the largest retailer of video games slid more than 7% on Thursday as GameStop (GME) reported earnings that have fallen 32% from a year ago. Management knew that comparisons to this quarter a year ago would not be favorable; it was this time last year that the ultra successful Grand Theft Auto 4 from Take Two Interactive (TTWO) was released with blockbuster sales. Even with this in mind, fiscal second quarter results missed by a nickel analysts expectations for $.28 per share. Same store sales figures were also extremely weak coming in 14.1% lower, although, through store expansions overall revenue fell only 3.7%. Essentially, analysts were pessimistic coming into this release, but the actual results were even worse. Gaming had been thought to be a relatively recession resistant industry, but that theory may be showing signs of cracking with the weak sales results.

GME Further troubling investors in GameStop, the company issued guidance for the year that was significantly lower than previously thought. This is the second straight quarter for a downward revision. Management now expects $2.40 to $2.64 in earnings through the end of the year, revised from $2.83 to $2.93. There is increasing competition in video game sales coming from Walmart (WMT) as well as Amazon.com (AMZN). Not to mention, Best Buy (BBY) and the others have now entered one of GameStop’s primary business lines of selling used games, which is a source of high profit margins. However, used game sales were up 19% in the quarter, evidence that GameStop is effectively fending off competition thus far.

There are reasons to be optimistic about the fate of GameStop. For one thing, video game consol maker Sony (SNE) has lowered its price on its PS3 system by $100 this week. GameStop executives have been clamoring for Sony to do just this, and flagging sales of the system prompted the move. For GameStop, this could mean renewed interest in the systems and an increase in foot traffic to stores. It is ultimately more important to push game sales, because hardware carries much lighter margins. Also, management at GME said that they would anticipate the other major gaming systems will likely follow suit in order to compete.

It appears that this year, perhaps more than others, the holiday season will be a make or break one for the video game industry. The delays of some major game titles just adds to the pressure on solid performance through the holiday season. The company’s COO Paul Raines has said that he expects a big release from Halo 3, and claims that Activision’s (ATVI) Call of Duty: Modern Warfare 2 could be the best selling game in GameStop history!

At Ockham, we think that after today’s selloff the valuation of GameStop is compelling at current levels, despite the performance of the last quarter. That is why we are maintaining our Undervalued stance. We look at things from a long term view than just quarter to quarter, and GameStop has grown sales impressively over the long term; more than tripling over the last 5 years. At the current price, GameStop is selling for less than 10x the low end range of its profit guidance. This is an attractive price for the video game sales industry leader. So, there are some headwinds for GameStop such as increased competition, but we think that much of the bad news is already priced into the stock.

Video Game Sales Weak, But GameStop is Too Cheap