Another Breakout Is on the Way for This Stock

Investors have bid up gaming stocks in 2020, and Nintendo (OTCMKTS:NTDOY, OTCMKTS:NTDOF) has been no exception. Nintendo stock has gained a healthy 34% so far in 2020.

But even that rally doesn’t seem to incorporate all of the stock’s potential. After all, other gaming names have done far better — and with good reason. The sector increasingly looks like a long-term beneficiary of the novel coronavirus pandemic.

Nintendo stock obviously is no exception. But it has a short-term boost on the way as well.

New consoles and a strong online holiday shopping season should drive better-than-expected results in coming quarters. Management guidance, meanwhile, looks exceedingly conservative.

Meanwhile, with NTDOY pulling back about 8% from last month’s highs, its valuation is attractive.

On the whole, then, Nintendo looks like a winner, and Nintendo stock looks set to resume a breakout that’s taken a breather in recent weeks.

The Pandemic Tailwind

The new pandemic has led many gamers to spend more on their hobby. It has also brought lapsed gamers back into the fold, as consumers worldwide looked for something, anything, to do during “stay at home” orders this year.

Both trends should be a tailwind for Nintendo stock — and not just in 2020. Existing gamers are far more likely to purchase the new gaming consoles on the way this year. I firmly expect a strong holiday season — in which consumers “reward” themselves for a difficult year — to boost those sales.

Obviously, that will help Nintendo game revenue. Meanwhile, the company reportedly has a new Switch on the way in early 2021. That unit is due for an upgrade, and a new model could spark both hardware and software growth.

So the near-term outlook appears bright. Nintendo management, however, isn’t singing the same tune.

Beat and Raise

Nintendo’s outlook for fiscal 2021, which ends March 31, doesn’t incorporate any growth at all. In fact, management expects sales to fall about 8%. Ordinary profit is projected to decline 20%.

Certainly, that guidance seems to undercut the bull case for Nintendo stock. But with all due respect to Nintendo management, I’m not sure I believe that guidance will be correct.

That’s because of the trends that I believe will drive a strong holiday season. It’s also because of how the guidance was released.

Nintendo first gave its outlook on May 7, when it released fourth quarter earnings for fiscal 2020. Obviously, the world was in a very different spot at that point. We simply hadn’t seen the evidence of the short-term benefits in some sectors — including gaming — from the pandemic. In that environment, Nintendo no doubt aimed for caution.

Nintendo then reiterated that guidance on Aug. 6, along with its Q1 report — even though revenue in the quarter actually rose 2.4%.

The unchanged outlook does make some sense. There’s still some uncertainty in the world, and it would look somewhat strange for Nintendo to jack up its outlook after just one quarter.

But after two quarters, such a move would make more sense. And so I firmly expect that the Q2 release next month will include a raised outlook. There’s simply too much demand out there for Nintendo sales to fall 8% for the full year.

That raised outlook provides a potential catalyst for Nintendo stock, particularly with the pullback of the last few weeks.

Nintendo Stock Is Not Expensive

But there’s another aspect of the guidance to consider. Based on the current outlook, Nintendo stock is not terribly expensive.

Per share, Nintendo expects 1,679 JPY in profit — about $16. That’s $2 per NTDOY ADR (each American Depository Receipt is one-eighth of a full share).

In other words, NTDOY right now is trading at about 33x this year’s earnings. But I don’t believe that’s the correct way to look at it. Rather, it’s trading at 33x a depressed estimate of this year’s earnings — during a year in which a pandemic which had some impact on sales and raised expenses as well.

Nintendo’s actual earnings power is far higher. And so with NTDOY at $67, investors are paying something in the range of 25x normalized earnings.

In this market, that’s a multiple usually assigned to companies that are growing little, if at all. Nintendo will not be one of those companies. An expanding global gaming market, an impressive stable of intellectual property, and a new console cycle combine to suggest revenue should grow nicely over the next few years and beyond. And with net profit margins in the range of 20%, a good chunk of those incremental sales will drop to the bottom line.

So, yes, Nintendo stock has gained 34% so far this year. It should still have further to run.

— Matt McCall

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Source: Investor Place