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The Ratings Game: GameStop stock suffering worst day in 7 weeks after downgrade, disappointing results

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GameStop Corp. was downgraded Wednesday to the equivalent of a sell rating by Wedbush analyst Michael Pachter, who praised management and the business outlook but expressed concern over excessive valuation.

The downgrade comes after the videogame and consumer electronics retailer reported late Tuesday fiscal fourth-quarter profit and sales that missed Wall Street expectations, prompting negative comments from analysts.

The stock
GME,
-19.97%

tumbled 18.4% in afternoon trading following the results, putting them on track for a fifth-straight decline, and the biggest one-day selloff since it plummeted 42.1% on Feb. 4. It has shed 29.4% during its losing streak, but was still up 45.7% month to date.

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Pachter cut his rating to underperform, after being at neutral since March 2020. He raised his stock price target to $29 from $16, but his new target is about 80% below current levels.

Pachter said he believes GameStop is set up to be a “primary beneficiary” of the new gaming console launches, putting the company on track to return to full-year profitability in fiscal 2021. He said the raised price target reflects “excellent execution” by management amid an “exceedingly difficult” competitive environment. But the share price is just too high.

“The high-profile sustained short squeeze seen in recent months, however, has spiked the share price to levels that are completely disconnected from the fundamentals of the business,” Pachter wrote in a note to clients.

The stock had soared 1,625% in January, and has rocketed 3,463% over the past 12 months, as the so-called meme stock was the poster child of the trading frenzy stoked by social media surrounding heavily shorted stocks. In comparison, the S&P 500 index
SPX,
+0.27%

has gained 60% over the past year.

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Of the seven analysts surveyed by FactSet who cover GameStop, four have the equivalent of sell ratings while the others are at the equivalent of hold. The average price target is $40.64, or about 73% below current prices.

BofA Securities analyst Curtis Nagle was one of GameStop’s bears, and he reiterated his underperform rating and $10 price target on the stock after the company’s earnings report.

He said reported adjusted earnings per share of $1.34 were below consensus expectations, even as results were boosted by a large tax credit, which the company reported at $69.7 million. Meanwhile, Nagle said earnings before interest, taxes, depreciation and amortization (EBITDA) “misses in a big way,” as the reading of underlying profitability came in 66% below his estimate of $144 million.

Nagle said that while GameStop (GME) has taken steps toward a turnaround, such as adding new board members and senior management with digital experience, the company provided “very little detail” on its plans, aside from product-line expansion for “adjacent” gaming categories,” better customer experience, tech and fulfillment.

“We continue to be very skeptical on GME’s efforts to address its long-standing issue of digital disintermediation and the fact that its core market in new and pre-owned console gaming is shrinking at a rapid pace,” Nagle wrote in a research note. “GME also called out leveraging its existing digital assets like its PowerUp rewards program, but this has seen declining engagement for years.”

Meanwhile, credit analyst Mathew Christy at S&P Global was also downbeat on GameStop’s results, as the full-year operating net loss from continuing operations of $214.6 million was more than double his forecast for losses of about $100 million.

“We expected a better performance during the quarter due to our anticipation that its customers would begin to satiate their pent-up demand for the latest generation of video game consoles, which were released in late 2020,” Christy wrote.

He said business risks remain elevated, as the company’s intention to “reinvent itself with a digital focus” will involve “sizable execution risks and, potentially, a material increase in its capital investments.”

S&P Global rates GameStop credit at B-, which is six notches deep into speculative grade, or “junk” territory.

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