Video game giant Nintendo (NTDOY 0.63%) is posting some huge numbers thanks to the COVID-19 pandemic fueling gaming demand, as well as superb execution on the Nintendo Switch console in its fourth year since launch.
Still, Nintendo's stellar results beg the question: Where can earnings possibly go from here? The video game business is notoriously cyclical based on console releases. The past year could mark the apex of the Switch's earning power.
On the other hand, some believe Nintendo's beloved characters and brand power could open up new markets beyond video games, making its addressable market bigger and results more consistent. If that's the case, Nintendo shares could still be a buy. So which is it?
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Another strong quarter
Nintendo just reported results for the third quarter of fiscal year 2021 that were well above expectations. For the nine months ended in December 2020, revenue grew 37.3% to 1,404.4 billion yen ($13.38 billion). When a video game platform is a big hit, so much of those incremental sales fall straight to the bottom line. Operating profits rocketed 98.2%, and net profits of 376.6 billion yen ($3.6 billion) were up 91.8% over the prior year.
To give a sense of how big those numbers are, Nintendo already exceeded its original full-year targets for both revenue and profits in just three quarters. Helping this year's results was the Switch Lite, which was only introduced in September 2019. However, the four-year-old original Switch outperformed even more over the prior year, so the platform is still going strong. A great lineup of games also fueled 43% overall software growth, anchored by the massive hit Animal Crossing: New Horizons.
Is this peak earnings?
Nintendo's stock shot up on the massive quarter, but some investors may be wondering if this is as good as it gets. After all, we're entering the fifth year of the Switch console, and a typical life cycle for modern consoles is only about six years. In addition, the unique circumstances of the pandemic could have pulled forward sales from future years. With stimulus checks in the hands of consumers who can't travel, it's no surprise that 2020 was a bumper year for video games.
Currently, Nintendo trades at 17.5 times earnings, below the overall market and certainly very cheap for a high-quality growth company, but it wouldn't necessarily be cheap for a cyclical company experiencing peak earnings. So which is it for Nintendo?
Nintendo's paths to further growth
Nintendo's results could stagnate or decline once economies reopen after a vaccine is distributed. However, that could also be a boon for its brand-new theme park, Super Mario World, which is set to open on Feb. 4 in Japan. The theme park was originally supposed to open this past summer in conjunction with the Olympics, but that was pushed to February due to the pandemic. Nintendo also has anticipated rollouts in California, Florida, and Singapore.
Meanwhile, a Super Mario movie is slated to hit theaters in 2022. Even though Nintendo has many beloved characters, it hasn't really exploited them outside of video games. There was an ill-fated Mario movie back in 1993, but that's it.
If Nintendo executes the Mario movie better this time, and if Super Mario World gets a good reception, the company could be on its way to becoming more like Disney, able to monetize its beloved characters in many ways. Disney's parks segment was its highest-revenue segment prior to the pandemic.
Nintendo isn't running its theme parks, only licensing them to Comcast-owned Universal Studios. However, success in these new ventures could start a new chapter in which Nintendo continues to monetize hit IP in more ways than it has in the past.
Gaming should also be strong
Investors should still focus on the video game business for Nintendo. It's going to be the main business for years to come. The video game industry is still growing, and it's also possible the Switch could remain a strong seller for longer than a typical modern console cycle. After all, the original consoles in the '80s and '90s sometimes lasted 10-20 years. Nintendo just purchased Vancouver-based Next Level Games in early January, a Nintendo developer responsible for the successful Luigi's Mansion. Clearly, Nintendo is focused on growing its core video game business as best it can. It's been quite successful on that front for the past five years.
While the reopening trade may be a short-term headwind after last quarter's blowout, investors should pay attention to Super Mario world and progress on other IP fronts. If successful, it could point to bigger things for Nintendo in the future, even beyond "peak Switch."
