Stocks to sell

GameStop Could Fall 10% to 20% Based on Its Cash Burn

GameStop (NYSE:GME) released its earnings on Dec. 8 for its fiscal Q3 ending Oct. 30 with excellent results. It showed that revenue had jumped 29% year-over-year (YoY) to $1.297 billion, up from $1.0047 billion a year ago. However, it also showed that cash burn had jumped significantly during the third quarter. That is going to hurt GME stock and lower its valuation.

GameStop (GME) video game and electronics store logo sign in Bay Terrace, Queens, NY.

Source: quietbits / Shutterstock.com

However, a major reason why the cash burn turned negative was GameStop’s desire to “front load” its inventory balance prior to Christmas. The company said that ending inventory was $1.141 billion compared to $861 million at the end of July.

This $280 million increase in inventory accounts for much of the huge increase in cash burn during the quarter. For example, on page six of the earnings release, the cash flow from operations for Q3 was negative $293 million.

It is interesting that GameStop produced a quarterly cash flow statement, which it normally does not do. That tells me that it wanted to go to great lengths to make sure its higher cash burn was in order to build its inventory in time for Christmas.

As a result, despite the higher cash burn for the quarter, I believe that this could end up reversing out during the Christmas quarter and thereafter. In other words, this will not be a consistent cash burn pattern. In fact, in my last article on GameStop, I argued that the company was getting close to positive free cash flow.

Where Things Stand at GameStop

After peaking at $247.55 on Nov. 22, GME stock plunged to a current low of about $154, the lowest it’s been in several months. That still represents a drop of 38% from its peak in just a few weeks. It’s almost as if the market knew that the Oct. 30 quarter would be difficult.

However, let’s keep everything in perspective. The fact is GME stock started out this year at $18.84 per share on Dec. 31. That means it is still about 8.2 times the price at the end of 2020 and the 720% gain is quite a performance for a company that once was considered close to going bankrupt.

Moreover, in the quarterly results announcement, GameStop said it was now debt-free. That is, it’s debt-free other than a small $46 million low-interest, term loan associated with the French government’s response to COVID-19.

In addition, it still has $1.468 billion in cash on its balance sheet, including restricted cash. In addition, it has access to an ABL (asset-backed loan) facility for up $500 million, giving it plenty of liquidity to withstand any increase in cash burn.

Nevertheless, other financial aspects of the company still are not improving. For example, its gross margin percentage of sales fell to 24.6% from 27.5% a year ago. In fact, last quarter ending July 31 its margin was better at 27.1%. So pricing pressure and most likely higher shipping costs cut its margin from the high 20% to below 25%. That does not help its ongoing profitability.

The same is true for its operating margins. In Q3, operating margins worsened to negative 7.9% from negative 6.3% a year ago. Moreover, it was just negative 4.9% in Q2.

In other words, GameStop’s margin and cash flow performance were much worse this quarter. That is not going to do any wonders for GME stock at this point.

What to Do With GME Stock

At this point, I would expect that GME stock is going to take a hit of some magnitude. I suspect it could fall at least 10% to 20% from here (in fact it’s already down 11% before end of trading on Dec. 9). The truth is investors are not going to wait for the company to turn profitable. They wanted to see something positive during Q3. The fact that margins and cash flow became worse is probably disheartening to a good many investors.

Nevertheless, the upcoming quarter ending January is always the highest performing for the year, in terms of sales and cash flow. This is what investors are hoping to see will help turn the company around.

However, for the time being, most investors should expect to see GME stock go lower. They should wait for another chance to buy in later this month or after Christmas.

On the date of publication, Mark Hake did not hold (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.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

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