MemeMoney: GameStop: Cash burn and lack of profitability loom large over meme stock darling

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Meme stock GameStop has been on a wild ride in the last couple of years, but cash burn and lack of profitability loom large over the video game retailer.

Last week GameStop Corp’s GME, +1.01% stock surged after the the company reported a narrower-than expected loss and also announced a partnership with cryptocurrency exchange FTX.

GameStop shares, which have fallen 24 % this year, have risen 9% in the last five days. The S&P 500 Index SPX, -0.63% has declined 17.9% and 2.3%, respectively over the same periods.

Like AMC Entertainment Holdings Inc. AMC, +0.05%, GameStop is a meme stock darling. Earlier this year GameStop rocketed to its longest win streak in over a decade, boosted in part by a bullish post on the WallStreetBets subreddit.

GameStop, like AMC, was a major beneficiary of the meme stock buying frenzy in January 2021, sending the struggling company’s stock skyrocketing to dizzying heights. Between January and March 2021, GameStop’s stock price rose more than 1,200% and the company’s market cap surpassed $17 billion. GameStop’s market cap is now around $8.6 billion.

See Now: GameStop stock jumps 12% after retailer’s narrower quarterly loss, crypto deal

As of Jan. 29, 2022, GameStop had 3,018 stores in the U.S., according to an SEC filing, down from 3,192 a year earlier.

GameStop is clearly still capable of generating buzz, but what is the reality behind all the noise?

Independent equity research firm New Constructs added GameStop to its list of “zombie stocks” in August.

The research firm, which uses machine learning and natural language processing to parse corporate filings and model economic earnings, has been bearish on GameStop for much longer, according to New Constructs CEO David Trainer. New Constructs first highlighted the risk posed by GameStop in a report in April 2021, he told MarketWatch.

“GameStop was a struggling brick-and-mortar retailer before it entered the meme-stock stratosphere,” he said. “The meme-frenzy distracted from business fundamentals, but becoming competitive again will be no easy task.”

See Now: GameStop stock rises after narrower-than expected loss but company ‘remains a mess,’ Wedbush says

Cash burn, in particular, is an issue. “Since 2020, GameStop has burned through $727 million in free cash flow,” Trainer added. “The cash drain is getting worse as the company burned through $263 million in FCF excluding acquisitions over the trailing 12 months ended fiscal 1Q23, which is down from positive FCF excluding acquisitions of $46 million in the TTM ended fiscal 1Q22.”

They (meme investors) are definitely the same kind of dynamic you see in a cult.’

— George Pearkes, analyst, Bespoke Investment Group

There is also limited cash available, according to Trainer. “GameStop’s cash balance could only sustain its cash burn for another 18 months after fiscal 1Q23, assuming cash burn is similar to the TTM,” he said. “Raising additional capital to fund a business that has failed to improve profitability over the past four years and faces heavy competition in the retail/ecommerce market would likely be very expensive, if not impossible.”

GameStop ended its most recent quarter with cash and equivalents of $908.9 million. The company also said it ended the quarter with no debt other than a low-interest loan related to the French government’s response to the pandemic.

In its second quarter, GameStop reported quarterly sales of $1.136 billion, down from $1.183 billion in the prior year’s quarter and below the FactSet consensus of $1.266 billion.

The retailer’s recent results also marked GameStop’s sixth consecutive quarterly loss.

See Now: ‘Zombie’ stocks AMC and GameStop could feel the cash burn, says New Constructs

New Constructs’ Trainer cites GameStop’s “ongoing lack of profitability” as a major problem. “GameStop’s net operating profit after-tax (NOPAT) margin and return on invested capital (ROIC) are worse than during GameStop’s fiscal 2021, which occurred largely during the COVID lockdowns of 2020,” he said.

Set against this backdrop, Trainer isn’t confident of GameStop’s chances of exiting the list of zombie stocks. “It is unlikely that the company will ever make enough money to satisfy stakeholders with higher claims on the company’s cash flows than common equity shareholders,” he said. “Not surprisingly, GME has an economic book value, or no growth value, of -$19/share.”

“In other words, we do not think equity investors will ever see $1 of economic earnings, which means the stock is worth $0 today,” he added.

Others are also unconvinced by GameStop.

“Fundamentally, GameStop remains a mess,” wrote Wedbush analyst Michael Pachter, in a note released last week. “The company has lost money for the last six consecutive quarters, and has lost over $700 million since January 2019.”

See Now: Is the golden age of the meme stock rally over?

Additionally, Pachter is not convinced that the FTX deal will move the needle for GameStop. “Financial terms were not disclosed, though we are skeptical that the partnership will drive meaningful revenue or profit contribution,” he wrote.

Wedbush lowered its GameStop price target to $6.00 from $7.50 and maintained its underperform rating. The new price target implies about 76% downside from current levels, according to Pachter.

Bespoke Investment Group Analyst George Pearkes is also critical of the social media-fueled buying frenzy that turned GameStop, like AMC, into a meme-stock darling. “They are definitely the same kind of dynamic you see in a cult,” he told MarketWatch.

While he acknowledges that this is not true of everybody that owns the stocks, the analyst says the noise surrounding meme stocks and reality are two different things. “Regardless of how big the investor base is, their talk is probably much larger than their holdings,” he said. “The amount of propaganda and promotion is probably far, far larger than the positions they hold.”

This article was originally published by Marketwatch.com. Read the original article here.

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