The market continues to sleep on Nintendo (NTDOY 3.03%). The Japanese video game giant and owner of family-friendly entertainment characters such as Mario, Zelda, and Bowser just reported phenomenal earnings but has seen shares of its stock fall around 10% in recent trading days. Despite trading at a discounted earnings multiple on cyclically low-profit numbers, short-term traders have soured on the stock. This provides an opportunity for investors who care about more than just the next couple of quarters.
Here's why -- after its recent price drop -- Nintendo is one of the cheapest high-quality stocks investors can buy today.
Nintendo's strong Q1 earnings
In the first quarter of fiscal year 2024, Nintendo reported strong growth and profitability. Revenue grew 50% year over year to $3.22 billion, with operating profit growing a whopping 82% to $1.3 billion just for the three months ending in June. This huge boost in sales and profits is due to the release of two blockbuster entertainment products last quarter: The Super Mario Bros. Movie and The Legend of Zelda: Tears of the Kingdom video game.
The first movie coming out of a partnership with Illumination Entertainment, Super Mario, greatly surpassed expectations by generating $1.35 billion at the global box office. This makes it the top-grossing movie of 2023 so far, which doesn't include high-margin at-home purchases. The Zelda video game has sold 18.5 million units since launching in May, putting it well on its way to being one of the top-selling video games of 2023. At an estimated blended price point of $60 in U.S. dollars, the Zelda game generated over $1 billion in revenue for Nintendo through the end of June.
This blowout first quarter puts Nintendo in a great spot to surpass its full-year guidance of $3.14 billion in operating profit for fiscal year 2024. Investors were likely concerned that Nintendo didn't raise its guidance after putting out two hit titles in the quarter, but they need to remember that Nintendo is ultra conservative with its financial guidance and rarely raises its estimates. If it does, it is typically much later in the fiscal year.
Long-term growth in movies and theme parks
Starting a few years back, Nintendo made an aggressive push to expand its entertainment business outside of just video games. The two most promising expansions are into visual content (i.e., TV and movies) and theme parks.
After the success of the Super Mario Movie, Nintendo has hinted multiple times that the company will continue to invest in visual content for its franchises through its partnership with Illumination. Unlike Disney's Marvel -- which posts a long-term content plan for both fans and investors to help understand its strategy -- Nintendo is tight-lipped about any upcoming content releases. However, if the company starts releasing movies at a consistent cadence (which all indications say it will), the segment can help drive earnings growth for the foreseeable future.
Nintendo's theme parks are being built by Comcast's Universal Studios in a licensing deal that gives them access to Nintendo's entertainment characters. Putting up no capital for the parks, Nintendo will only earn a small cut from all theme park sales, but it will be at high profit margins.
To track the success of Nintendo's expansion into new business lines, investors should look at its Mobile and IP Income segment, which tracks all of its revenue outside of its dedicated video game hardware business. In the first quarter, Nintendo's revenue from this segment exploded 190% higher to $220 million, driven by the success of its first movie. Over the next five to 10 years, this segment should become an even larger portion of Nintendo's consolidated operations.
It all comes down to new gaming hardware
While movies and theme parks are nice, the core driver of Nintendo's business will always be video games. The company has seen a lot of success with its current hardware device called the Switch, which has sold close to 130 million units since launching in 2017. This has driven Nintendo's active player base from just 19 million in the 12 months ending in June 2018 to 116 million over the last 12 months, a more than fivefold increase in a few short years.
However, the Switch is getting old in the tooth, having been released seven years ago. Rumors have it that Nintendo is readying a Switch successor in 2024, which creates both an opportunity and risk for shareholders. A well-received piece of hardware will likely mean continued growth in active players and higher game sales over the next five years, which would lead to higher profits, especially when combined with the new movie and theme park segments. That hasn't always been the case with Nintendo, though. Some of its hardware iterations, like the Wii U in 2012, have totally flopped with consumers and caused Nintendo's earnings to plummet in the following years.
NTDOY Operating Income (TTM) data by YCharts.
Even with this risk, if Nintendo succeeds with this new hardware -- whenever it is released -- the stock looks incredibly cheap at today's $10.73 share price. At a current market cap of $50 billion, Nintendo trades at an enterprise value of $33.4 billion when you subtract out its giant $16.6 billion cash pile. Compared to its full-year guidance for $3.14 billion in operating profit, the stock trades at just 10.6x earnings.
And these are cyclically low earnings for the company. Looking back at 2021, Nintendo at one point generated around $6 billion in annual operating income with the Switch in high gear and foreign currencies at more elevated levels vs. the U.S. dollar. If Nintendo hits these earnings after releasing its next gaming hardware, the stock will be trading at just a 5.5 times multiple compared to its enterprise value. For an entertainment company with dominant global intellectual property (IP), this is a steal for investors focused on holding for the long term.
