Nintendo (OTCPK:NTDOY) shares are trading at 12.55 P/E and 2.8 EV/Sell. In this article, I outline why I think valuation is too cheap. I support my argument with a residual profit assessment. Anchor my hypotheses on the EPS analyst consensus estimates, a WACC of 8%, and a terminal value growth rate equal to expected nominal GDP growth, I find that Nintendo’s fair price target should be around $70/share. Thus, I am confident to conclude with a BUY recommendation for NTDOY shares.
Nintendo is a leading game company in Japan. The company designs, develops, manufactures and distributes entertainment consoles and games. There aren’t many companies that can match Nintendo’s history of ingenuity and continued success. Nintendo led the gaming industry as early as 1985 when the company released Donkey Kong for coin-operated machines; then continued its leadership with the Nintendo Entertainment System in 1985, the Game Boy in 1989, the Nintendo DS in 2004; Nintendo Wii in 2008 and Nintendo Switch in 2017. Additionally, Nintendo created and operates some of the world’s most popular gaming franchises, including Pokémon, Legend of Zelda, Mario Bros, and Wii Sports. Notably, Nintendo has sold cumulatively over 5.1 billion video games and over 800 million hardware units worldwide. In 2021, Nintendo was the 3rd largest game developer in terms of game revenue, with $15.3 billion in game revenue.
The case for Nintendo
There are several reasons why investors might consider investing in Nintendo. In the following, I would like to highlight four of them: strong brand equity, continued focus on innovation, favorable industry winds and strong financials.
Nintendo is a consumer brand. And brand equity is strongly correlated to the success of a consumer brand. First, brand equity significantly reduces marketing costs, including for new product launches. Second, brand equity strongly supports pricing power. Third, brand equity helps companies recruit and retain talent. According to 2021 inter-brand ranking, Nintendo is listed as the 70th most valuable brand in the world. In terms of game developer, Nintendo only trails Microsoft and Sony. However, there are strong arguments to be made that Nintendo might actually be the most valued gaming brand because Interbrand doesn’t break down brand value by industry. That said, while Nintendo is a pure games company, Microsoft and Sony are also venturing into different industry verticals.
Focus on innovation
Nintendo has proven to release industry-leading innovative products such as the Game Boy, Wii and Nintendo DS. In early 2022 there are rumors that Nintendo is working on a new console, likely a Nintendo Switch 2. While details have yet to be released, there are arguments that Nintendo plans to release a console capable of ultra-high resolution graphics similar to the PS5 and Xbox Series. That said, investors should note that Nintendo has gradually increased its R&D spending from around 550 million in 2017 to over 800 million in 2021, indicating that Nintendo is indeed working on something new.
Favorable industry tailwind
The game industry is currently valued at approximately $200 million and is expected to grow at a CAGR of 8% to 10% over the next five years, reaching approximately $350 billion in 2027. The strong growth, almost triple the expected growth of the GDP, is among other things driven by technological innovation. In fact, the recent VR/AR and metaverse speculations are closely related to the game industry and are expected to bring the game industry to the forefront of technology. Additionally, the Covid-19 pandemic has caused a massive wave of new players, boosting industry revenue and growth. Many readers may know that Microsoft has Anneounce to acquire Activision Blizzard for over $65 billion, underscoring the enormous value inherent in the gaming industry.
In 2021, Nintendo recorded a strong financial performance. Revenue grew approximately 35% year-over-year, from $12 billion in 2020 to $16.5 billion in 2021. Respectively, net income jumped 89% year-on-year on the other to hit $4.515 billion, or $4.74 per share, over the same period. Cash flow from operations was $6.4 billion and free cash flow was $2.9 billion, with the company allocating $1.28 to investing outflows and $1.83 billion in shareholder dividends. At the end of 2021, Nintendo held $16.37 in cash and cash equivalents and almost no financial debt. Looking ahead, analyst consensus estimates Nintendo’s EPS in 2022, 2023, and 2024 at $3.72, $3.58, and $3.89.
Let’s take a detailed look at the NTDOY rating. I constructed a residual earnings framework based on consensus analyst forecasts for EPS through 2025, an 8% WACC, and a TV growth rate equal to nominal GDP growth. NTDOY’s 8% WACC is conservative given the company’s net cash position and the continued low interest rate environment in Japan. If investors wish to consider a different scenario, I have also attached a sensitivity analysis based on a varying combination of WACC and TV growth. For reference, red cells imply overvaluation, while green cells imply undervaluation relative to NTDOY’s current valuation.
Based on the assumptions above, my valuation estimates a fair share price of $69.49/share, implying 22.4% upside potential based on accounting fundamentals. However, the sensitivity chart indicates that Siemens’ valuation is heavily influenced by assumptions.
I would like to highlight two major downside risks that could cause Nintendo’s stock to differ materially from my price target:
First, a deterioration in the macro environment could negatively impact Nintendo’s business operations. On the demand side: including inflation, rising interest rates and falling asset prices could negatively impact consumer sentiment and entertainment spending. On the supply side: Supply chain challenges such as semiconductor shortages could slow down Nintendo’s production. If the challenges, on both the demand and supply side, turn out to be more severe and/or last longer than expected, the company’s financial outlook should be adjusted accordingly.
Second, while companies with high brand value such as Nintendo see relatively little impact from direct price competition or competitive cannibalism, Nintendo’s competitive positioning and future success is deeply tied to the ability of the company to innovate and market new products successfully. Nintendo’s ability to innovate and launch cutting-edge entertainment solutions needs to be further analyzed in relative context against competitors such as Sony and Microsoft.
I love Nintendo. It’s a solid company with lots of brand equity and attractive fundamentals. Additionally, the company’s stock is trading cheap – arguably too cheap at 12.55 P/E and 2.8 EV/Sell. In this article, I evaluate the company based on a residual results framework, anchored on the consensus of EPS analysts. My calculation reveals that the stock is significantly undervalued and indicates a fair base target price of $69.49/share.