GameStop's Cheap Valuation Draws Upgrade

   By Dan Gallagher 
 

With video game sales in a slump for the year, and competition rising in the used game space, investors have punished GameStop Corp. (GME), pushing its stock to its lowest valuation level in at least five years.

The stock has been trading at about 9.5 times estimated earnings for the next four quarters. According to relative valuation data from Thomson Reuters, that's about 53% below its average valuation over the last five years. It's also one of the lowest price-to-earnings ratios among other specialty retailers.

GameStop shares have also under-performed the strong run-up in the broader market over the last six months -- losing more than 10% compared to the 30%-plus gain for the Nasdaq.

Wedbush Morgan upgraded GameStop to an outperform, or buy, rating Thursday, citing the company's low valuation and upside potential.

"We believe that GameStop's current valuation is compelling, and we expect the company to benefit from several near term catalysts, including hardware price cuts, a much improved software release slate, and much easier industry sales comparisons," Wedbush analyst Michael Pachter wrote in a note to clients Thursday.

Shares of GameStop were trading up 2.9% at $27 by midday Thursday.

Video game sales have been in a sharp slump for the last six months, as the industry grapples with the economic downturn as well as difficult comparisons to last year, when several of the hottest titles came out early in the period.

Pachter and other analysts widely expect September sales to show an improvement, thanks to big game releases such as "The Beatles: Rock Band," "Guitar Hero 5" and "Need for Speed: Shift." Also, console makers Sony Corp. (SNE), Microsoft Corp. (MSFT) and Nintendo (NTDOY) have all cut the prices on their devices.

The NPD Group is expected to report video game sales for the month of September on Thursday, Oct. 15.

Another pressure for GameStop has been growing competition in the used game category - which offers much higher margins than new game sales. Retail giants Wal-Mart (WMT), Toys "R" Us Inc. and Amazon.com (AMZN) have launched used-game trade-in services this year.

Pachter believes GameStop will maintain much of its business despite its new rivals, because much of the trade-in business comes from young men who need used game credits to afford newer titles.

"We estimate that unemployed boys [most boys under 18] make up the bulk of GameStop's trade-in customers, and the company has a competitive advantage insofar as it encourages teenagers to visit and stay in its stores," he wrote. "This is not true of Wal-Mart or ToysRUs, and we think that GameStop's openness to this core customer group will provide a competitive advantage for years to come."

Wall Street was already bullish on GameStop. Out of the 17 analysts covering the stock, 16 now rate the shares as a buy, according to Thomson data.

-By Dan Gallagher; 415-439-6400; [e-mail]