BofA warns GameStop stock could plunge 93% as weak earnings and skeptical turnaround plan will weigh on the business
- GameStop's epic short-squeeze rally is not changing Bank of America's mind on its long-term outlook.
- The bank reiterated its Underperform rating on the stock, but increased its price target to $10 form $1.50 in a note on Wednesday.
- "A potential turnaround helped in part by new board member Ryan Cohen will not be nearly meaningful enough to offset structural pressures," BofA said.
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GameStop's epic short-squeeze rally sparked by a group of traders that frequent Reddit's WallStreetBets forum won't change the company's dismal long-term outlook, Bank of America said in a note on Wednesday.
The bank reiterated its Underperform rating on the video-game retailer, but increased its price target by 567% to $10 from $1.50 to account for the gob-smacking 1,783% year-to-date rally in shares, based on Wednesday's intra-day high of $354.83.
BofA's price target represents 93% downside potential from Tuesday's close.
BofA concedes that a tight supply of shares is driving gains right now, and high short interest combined with strong retail investor enthusiasm could continue to support momentum going forward, according to the note.
But GameStop's share price "implies EBITDA that isn't likely," BofA said, adding that it remains skeptical of a turnaround plan.
That turnaround plan has been spearheaded by Chewy.com co-founder Ryan Cohen, who acquired a 12.9% stake in the company last year and urged its management team to transform into a specialized e-commerce gaming retailer.
GameStop seems to be onboard with Cohen's plan and added him and two of his associates to its board of directors earlier this month.
The company has already seen its online sales surge to 30% of its total sales thanks to the pandemic, but Bank of America isn't buying into Cohen's turnaround plan.
"We see a higher mix to online as a negative for earnings. Very simply, the more business that shifts from in-store transactions, the more difficult it will be to sell high margin pre-owned and collectibles merchandise which accounted for 46% of gross profit dollars in 2019," BofA explained.
While momentum could continue to put upward pressure on shares, ultimately GameStop's earnings should serve as a reminder that its current valuation is extravagant, the note said.
"We think fundamentals will again factor into valuation and note that at current price of $148 and GameStop's five year enterprise value of 3.7x it implies EBITDA of $2.6 billion vs $(65) million in 2020," BofA explained.
To grow into this valuation, GameStop would need to experience a massive increase in both current sales and profit margins, but that's "improbable" given higher digital penetration of video game downloads, weakness in high-margin categories like pre-owned gaming, and steady market share losses relative to the past, the bank said.
For now, investors are brushing aside Bank of America's bearish call on the stock, with shares of GameStop trading up as much as 140% in Wednesday trades.
