Japanese video game company Nintendo (NTDOY 0.66%) just released an action-packed full-year report. The business behind the hit Switch gaming system saw its sales and profits rise in tandem over the last 12 months, but the stock ended up declining slightly following the report to due weak guidance for hardware and software sales in the current year.
While soft guidance is never great, Nintendo is presenting long-term investors a gift with its stock down over 11% year to date. Let's dive deeper into the numbers and see why that's the case.
Image source: Getty Images.
Sustained Switch sales
The big concern with Nintendo is its history of launching gaming hardware that becomes popular for a few years but then falls out of favor (like the Wii or Gamecube). Four years after launching, it looks like Nintendo has bucked the trend with the Switch. Last year, it sold 231 million software units (games), up from 169 million the year before. Sustained software sales are a big indicator that Switch customers are still using the system regularly.
From a financial perspective, software sales drive the majority of Nintendo's profits, as they tend to have extremely high margins relative to the Switch hardware itself. What's more, digital sales as a percentage of software sales increased almost nine percentage points to 42.8% last year, which was a big contributor to Nintendo's operating margin rising from 26.9% to 36.4%.
Nintendo is guiding for sales of 26 million Switch units and 190 million software units in the current fiscal year, both a decrease from the 29 million and 231 million it sold last year. But investors should remember that Nintendo is always ultra-conservative with its guidance. For example, last May, in the heat of the pandemic when Nintendo already knew it was seeing a boost in sales due to the lockdowns and the blockbuster release of Animal Crossing: New Horizons (which went on to sell 21 million units last year), it guided for only 19 million hardware units and 140 million software units, which it handily beat.
So when you see that Nintendo expects a decrease in sales, profits, and units sold this year, any investor should understand that historically, the company tries to underpromise and overdeliver with its results.
Non-Switch initiatives
Outside of the Switch, which currently makes up the majority of Nintendo's sales and profits, it has a few other initiatives that should soon start to bear fruit. For one, Nintendo is getting into the theme park business through a partnership with Universal. The pair are planning on opening up four Nintendo-based theme parks around the world over the next few years in Japan, Singapore, California, and Florida. The location in Japan is already open, but it has faced some short-term headwinds due to the COVID-19 pandemic.
Nintendo is also getting into animated movies in a partnership with Illumination Studios. A Mario movie is coming out in 2022 with other titles planned for the future. Illumination CEO Chris Meladandri just got nominated to Nintendo's Board of Directors as well, so it looks like the partnership is deepening with new opportunities for the gaming company going forward.
Lastly, Nintendo just announced a new partnership with Niantic to make augmented reality-focused mobile applications with Nintendo's characters. The first app will be with the lesser-known Pikmin franchise, but you can expect apps from more popular Nintendo characters to launch over the next five years.
Valuation
Nintendo has a market cap of $69 billion as of this writing, but if you back out the $18 billion in cash, securities, and investments sitting on its balance sheet, the enterprise value comes down to $53 billion, and that's before considering its ownership of the Pokemon Company and its Series A investment in Niantic.
At this current valuation, the stock trades at just 12 times last year's operating profit and 15 times management's operating profit guidance for this year (which it routinely beats). Plus, Nintendo has continuously raised its dividend payout, which now yields 2.7%.
If you believe Nintendo can sustain or grow its bottom line over the next few years, the stock looks like an attractive buy. Yes, there is a risk that the Switch gaming system will fall out of favor with gamers like the Wii did a decade ago, but so far, the company has shown the lessons it learned from prior console lifecycles. Taking all these factors into consideration, if you are a value-focused investor with a long time horizon, Nintendo is a tremendous opportunity at current prices.
