NCBDY - Capcom's Resident Evil 4 Release: Welcoming The Zombie Masterpiece

2023-03-23 05:29:14 ET

Summary

• The release of the classic 'Resident Evil 4' remake will be a major success, driving earnings strongly in Q4 FY3/2023.
• We believe the company will upwardly revise company guidance as a result and will enjoy high earnings visibility into FY3/2024.
• For a quality game content business with high margins and sustainable growth, we reiterate our buy rating.

Investment thesis

We believe the release of 'Resident Evil 4' will be a major success in Q4 FY3/2023, resulting in a strong finish to the current year as well as high earnings visibility into FY3/2024. With a sustainable growth profile, we reiterate our buy rating.

Quick primer

Capcom ( OTCPK:CCOEF ) is a Japanese video game developer and publisher with core franchises such as 'Resident Evil', 'Monster Hunter' and 'Street Fighter'. It also develops arcade game machines, pachinko/pachislot (Japanese gambling machines), and operates 'Plaza Capcom' arcade centers. Its peers include BANDAI NAMCO ( OTCPK:NCBDF ), Sony ( SONY ), Kadokawa ( OTCPK:KDKWF ), and Sega Sammy ( OTCPK:SGAMY ).

Key financials with consensus forecasts

Our objectives

The reviews are now available for the Q4 FY3/2023 software release of the 'Resident Evil 4' remake on the PlayStation 4/5, Xbox Series S/X, and PC. As remakes can be a risky manoeuvre for game companies, especially with core IP, we want to revisit our buy rating from January 2023.

Initially developed for the Nintendo GameCube in 2005, 'Resident Evil 4' has been re-released on multiple platforms since and is considered to be one of the most influential video games ever developed. The title will have a global release on March 24th, 2023.

Critical acclaim - again

The critics have lavished praise on Capcom's remake of 'Resident Evil 4', talking about how the classic game has been updated to modern gaming standards. It would appear that the company has done a decent job, aiming to appeal to diehard fans of the original as well as bringing in new gamers to the franchise. Here is a selection of reviews - Pocket-lint , VGC , Metacritic , and IGN .

As an indication, Amazon's sales ranking shows the title at the top of 'PlayStation 5' rankings in the US and UK , but number 2 in Japan (with Square Enix's ( OTCPK:SQNXF ) 'FF16' at number one). Overall rankings show Nintendo's ( OTCPK:NTDOY ) 'Legend of Zelda' as the leading software title, but the release will be in May 2023 and arguably is not a directly competing title (although there will be some pressure on gaming dollars).

With the coast clear for a successful release, we believe Capcom will have a multi-million-unit seller which will allow for a strong finish for Q4 FY3/2023, as well as earnings visibility into FY3/2024 with repeat sales.

A closer look at the numbers

Consensus forecasts for FY3/2023 (please see Key financials above) show market expectations to be only slightly ahead of company guidance ( top page at bottom ) for operating profit (JPY51 billion versus company guidance of JPY50 billion). This is understandable given the implied high concentration of earnings required to meet forecasts in the last quarter of FY3/2023, chiefly 33% of total FY operating profit. This is a fairly tall order, but performance has been robust to date with demand for the 'Monster Hunter Rise: Sunbreak' expansion on the Switch, together with the January 2023 release on PlayStation 4/5, and Xbox Series S/X of 'Monster Hunter Rise'.

If we take a very conservative view that all of the company guidance-implied sales (JPY45 billion/USD333 million sales) for Q4 FY3/2023 will have to be generated by 'Resident Evil 4' alone, this roughly equates to 7.5 million unit sales for the title (assuming JPY6,000/USD44 per unit sale). Is this possible within 8 days before the financial year's end?

Taking a look back at the last key release in the franchise 'Resident Evil Village' in May 2021, this title sold over 4.5 million units in just over one month ( page 9 ), with the majority of sales being digital. With stronger reviews and a larger installed base of consoles (we estimate over double the size), we believe initial sales should be significantly higher for 'Resident Evil 4'. We believe it will become the fastest-selling title in the franchise, and should reach over 6 million unit sales in under a week. Essentially, we believe company guidance will be comfortably beaten.

We believe this title will sell over 10 million copies in the next 12 months, pointing to a strong start to FY3/2024 with repeat sales. The other major releases include 'Monster Hunter Rise: Sunbreak' on PlayStation 4/5 and Xbox Series S/X, and the 'Street Fighter 6' title.

Valuation

The shares are trading on consensus PER FY3/2024 25.0x, and a free cash flow yield of 3.0%. Whilst these multiples do not denote a major undervaluation, we believe the combination of sustainable growth, steady ROIC above 15%, and a strong net cash balance sheet make the shares attractive.

Risks

Upside risk comes from 'Resident Evil 4' performing significantly above current market expectations, resulting in an upward revision to FY3/2023 company guidance.

The company is in a position to deploy cash for a major share buyback.

Downside risk comes from a slow start to sales of 'Resident Evil 4', as well as technical hitches. There is already a day-one patch being made available to improve some graphic quality in the game.

Despite relatively high expectations, weak company guidance for FY3/2024 may dampen expectations for the short term.

Conclusion

We have assessed the reviews for 'Resident Evil 4' and believe the title will perform very positively. Our expectation is that sales volume will be high, resulting in beating company guidance by a material margin, and the outlook for FY3/2024 will be strong with repeat sales. We reiterate our buy rating on Capcom.

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