2023-07-27 17:52:39 ET
Summary
- The Nintendo Switch console has been a massive hit and has the potential to become the best-selling console.
- Nintendo's well-known video game IPs, such as Super Mario, Zelda, and Pokémon, will continue to be cash cows for the company.
- Nintendo is trading at a fair price and I think it is worth investing in due to its strong position in the console gaming industry.
Investment Thesis
I wanted to take a look at one of the gaming juggernauts, Nintendo ( NTDOY ), to see how the company is operating and what it has in store in terms of new releases, whether that would be new games, new iterations of the Switch, or a completely new console. In my opinion, the company is trading at a discount and is worth having some money in.
Outlook
Nintendo is in a great position in terms of where it stands in the console gaming industry. It has never competed with the likes of PlayStation ( SONY ) or Xbox ( MSFT ) consoles. The consoles it produces are for a larger population of people. People who are more casual when it comes to winding down on the couch and picking up a game to play for a bit. In my opinion, Nintendo is the most creative company when it comes to releasing games because the lack of power in the hardware forces them to be more innovative. The games always look good and polished, and more video gamy than the stuff we usually get and want on the main consoles.
I think the company is also in a unique position in terms of being a handheld, mobile console. Mobile gaming is the largest revenue generator in the segment, and I would put the Switch console in that category too. So, the total addressable market is huge, especially in Asian markets where gaming on the go is really popular.
Consoles
The Nintendo Switch was a massive hit and has quickly become the 3rd best-selling video game console in the world (according to Wikipedia), right after the DS and the all-time leader and my personal favorite, the PlayStation 2. The Switch sales numbers jumped quite a bit once the OLED version came out, surpassing 125m units sold. I wouldn't be surprised if the console becomes the number one console in terms of sales, especially if Nintendo doesn’t release a new console any time soon.
Another positive for the company is that the price of the consoles is very accessible to many people, so when the next console is going to come out, the Switch 2 or whatever they decide to call it, I would think it will be within the same price range as the current one and that it will not try to compete with the PS or the XBOX any time soon.
Games
The company has the most well-known video game IPs in the world, and it will not stop milking them for many more years to come because if it ain’t broke why fix it, right? In my opinion, the success of Super Mario throughout the years and the boost it got from the recent movie is going to continue to sell very well in perpetuity. Nintendo Direct announced quite a few interesting games, which included a remake of Super Mario RPG (looks good) and an all-new Super Mario game called Super Mario Bros. Wonder.
On top of the Mario IP, they also have the Zelda and Pokémon franchises, which sell millions of units every year. The new Zelda game sold so well, that is on its way to becoming the best-selling in the franchise. Right now, that title still belongs to its predecessor, Breath of the Wild. In terms of Pokémon, there are no new installments in '23 apart from a DLC, but you know those will come in the future and will sell like hotcakes.
In summary, the company has a strong moat and is very different from the other two aforementioned consoles, and the company isn’t competing against them in any way in my opinion. The price is much more customer-friendly, and so are the games. The fantastic IPs it holds will continue to be cash cows for many years to come. I should also mention the company's venture into theme parks, with the Super Nintendo World recently opened up in Universal Studios Japan and Hollywood, with two more in the construction phase to be opened in 2025. I could see the company expanding further, becoming a mini-Disney ( DIS ) of sorts.
Potential Risks
Of course, no company comes without its risks and Nintendo is no different, no matter how bullish I may be. I mentioned earlier that Nintendo excels at innovation, which is very risky if the experiments do not pan out the way the developer thought they might. One of the earliest innovation flops of Nintendo I could think of is the Virtual Boy. It was well ahead of its time, and it just didn't work the way VR works right now.
Does anyone remember the Wii U? Yeah, I keep forgetting that the company made that also, however, it was an experiment that led to the great Switch console that we have right now. The point I'm trying to make here is the next console, no matter how hyped we all may be for it, could be a step back once again and sell very poorly if the experiments that Nintendo is going to try on the new console don't click with the consumer.
Nintendo is not a stranger to controversies. It has very stringent policies when it comes to streaming its IPs on the internet, which led to many content creators being banned or their content being taken down by the company due to copyright infringement. This may hurt the company's reputation in the long run, which may lead to lower sales of their games and lower viewership.
I know I said that the company may milk the main franchises for eternity, however, if the future installments became stale and soulless, people will stop buying them and the company will start to lose money. Nintendo cannot drop the ball here and needs to keep innovating to entice players.
Financials
As of March, ’23, the company had $9.4B in cash and $4.6B in short-term investments, bringing total liquidity to around $15B against zero debt. I think this is a great position for the company to be in because the company has a lot of flexibility and can do whatever they want with the massive pile of cash. They could go on a shopping spree and follow in the steps of Sony and MSFT and acquire a bunch of gaming developers. They can keep experimenting with innovative games and upcoming consoles.
The company’s current ratio is, as I suspected, a bit too high because of that massive liquidity. I'm not saying that it's bad to have a high current ratio, I'm just saying that the company could be a little bit more efficient with its assets, especially the cash pile. I'd like to see the current ratio be around 1.5-2.0 and right now it sits at around 4. At least, this tells us that Nintendo has no liquidity issues.
Nintendo’s ROA and ROE are also very good, but could be even better if it started to use its cash pile more. Nevertheless, it seems to me that the company is running efficiently and is creating shareholder value.
I am a little surprised that the return on invested capital or ROIC has come down slightly from a couple of years ago, and it seems to be down trending. It is still at that minimum threshold I like to see which is 10%, however, I wouldn’t want to see it going below that, and I’m sure the company’s competitive advantage and the moat it has will persist with future releases of blockbuster games and new consoles.
In terms of margins, I think these are already very healthy and the only bad thing I can see right now is that, like ROIC, these are trending down slightly, and I would like to see how these develop further. I would like to see margins going back to March ’22 levels at least.
Overall, in my view the company’s financials are very solid with no actual red flags and that is what I would like to see in any company, a clean, well-oiled machine that has a lot of dry powder for future innovations and experimentations.
Valuation
Over the last decade, the company averaged a 15% CAGR in terms of revenue growth. I will approach this with a little more conservatism and for the base case, I grew revenues at 7.5% CAGR. For the optimistic case, I went with 11.3%, while for the conservative case, I went with 5.5% CAGR over the next decade. In my opinion, these scenarios are somewhat on the conservative side and all three are very possible.
In terms of margins, I decided to keep these where they are currently to be even more conservative. On top of that, I also added a 25% margin of safety to be especially conservative because I like my risk to be mitigated completely. Is it overkill? Probably, however, I don't want to overpay for a company because even if it works out, the returns may be suboptimal in the long run if purchased at the wrong price. With that said, Nintendo’s intrinsic value is $11.25 a share, meaning the company is priced fairly.
Closing Comments
What the results above tell us is that the risk/reward profile is very favorable for me, and I would be looking forward to opening a position very soon. I may wait until the next earnings come out before jumping in, however, I think the financials are outstanding, and the company is making cash left and right, coupled with amazing IPs and little to no competition in the gaming space, Nintendo has a bright future ahead, and it will continue to innovate for years to come, as it has in the past.
The fact that the company has gone nowhere in the past year in terms of stock price appreciation tells me that people may be sleeping on this gem of a stock, and it would be a good time to jump in before the masses realize its potential.
For further details see:
Nintendo: Future Buyer Of The Company