Can Nintendo shares keep up the momentum?

Nintendo shares hit highest level since 2008

Nintendo shares hit their highest level since 2008 on 19 June as the Japanese video game company continues to build momentum during the coronavirus pandemic. Lockdown measures have forced many to stay at home and, while most sectors have suffered as a result, the gaming industry has proven to be one of the most resilient sectors this year.

Nintendo posted a set of annual results in May, covering the 12 months to the end of March 2020, and delivered its best year yet since launching the Nintendo Switch, the handheld and TV-hybrid console, three years ago.

Best year yet for the Nintendo Switch

The year was underpinned by the launch of the Nintendo Switch Lite, a cheaper and handheld-only version of the console that was only released in September, as well as a number of record breaking game releases.

Although sales of Switch consoles dropped year-on-year (YoY) it still shifted 14.8 million of them, and the decrease was more than compensated for by the sale of 6.2 million Switch Lite consoles. That resulted in overall console sales jumping 24% YoY to just over 21 million units, building on the 17 million it sold the year before.

Strong demand for new titles and blockbuster games

It was a very strong year for software sales, driven by new releases and the continued success of its blockbuster titles. In terms of new titles, Pokémon Sword and Pokémon Shield were the best sellers of the year with nearly 17.4 million copies sold, but it has been Animal Crossing: New Horizons that has grabbed the headlines.

The game, which simulates peaceful island life and encourages socialising online with friends, has been a huge success as its launch in March coincided with lockdown measures being introduced in Europe and elsewhere. It has already sold 11.8 million copies in just three months, making it the ‘best start ever for a Nintendo Switch title’.

These new titles, alongside strong demand for existing titles like Mario Kart 8 Deluxe and Super Smash Bros Ultimate, meant overall software sales soared to 168.7 million units from 118.5 million the year before.

Furthermore, with many physical shops closed, more gamers have been buying their games digitally and directly through their console, which yields significantly higher margins for the company compared to physical copies.

Below is a table outlining the top ten selling titles of the year, demonstrating the appeal of both old and new releases:

Can Nintendo keep up the momentum?

The Nintendo Switch is entering its fourth year and, while it has been revitalised by the launch of the Switch Lite, there are fears that it could have already reached its peak after Nintendo warned sales of consoles and games would fall this year.

Nintendo has said it expects to sell 19 million consoles in the year to the end of March 2021, down almost 10% from the year before, while software sales are expected to plunge 17% to 140 million units. The two are heavily interlinked: those who buy consoles then have to buy games to play, so fewer console sales translates to fewer game being bought. Although users continue to buy games for years after they purchase a console, these rely on a strong schedule of game releases.

As a result, revenue, profits and its dividend – which is tied to profits – will all be lower YoY, as outlined in Nintendo’s guidance:

Coronavirus causes uncertainty for Nintendo’s outlook

One of the major reasons that has prompted a conservative outlook from Nintendo is the coronavirus pandemic. Although demand has gone through the roof for the industry during lockdown, the virus has caused disruption. For example, Nintendo had to briefly suspend shipments of consoles in April because of a shortage and has experienced supply issues for equipment like controllers. While production and supply issues are easing and Nintendo has stressed the impact has so far been minimal on the business, it is aware that these problems could resurface this year if the coronavirus persists.

Nintendo admitted that it believed console sales were set to remain on a broad level this year before the coronavirus ‘grew to have such a wide impact’, and the reason it downgraded expectations is not because of a lack of demand but concerns over supply.

‘We are not in a position to be able to produce the full quantity of units we actually want to produce. That said, there are signs of gradual improvement, and so we anticipate that the impact of Covid-19 on production will subside to some degree by summer and that the volume we will be able to produce throughout the year will align with our sales forecast units for this fiscal year.

But if the impact is prolonged or worsens further, and parts procurement and/or manufacturing are affected again, then there is a possibility that we will be unable to produce the quantities needed to fulfil our current sales forecast,’ Nintendo said in May.

Nintendo to rely more on existing games

Nintendo’s game pipeline could also be greatly impacted by the coronavirus, depending on how long it lasts. While more time at home encourages more gaming, it makes it incredibly difficult to make them. Quite simply, despite the wonders of technology, there are ‘big limitations’ to what developers can achieve on their own at home rather than as a team in the office.

‘In particular, the impact to overseas subsidiaries and other affiliated companies involved in development is anticipated to be even more difficult to predict than within Japan. As a result of these factors, we may not be able to proceed with the release of Nintendo products and the start of services as planned,’ Nintendo has warned. ‘At this point, we are presenting our financial forecast on the assumption that titles can be released as planned.’

So far, Nintendo is yet to reveal a blockbuster release for this year apart from the release of Xenoblade Chronicles Definitive Edition, which was launched at the end of May. No releases have been confirmed past the summer, meaning not much is known about what to expect in the latter half of this year and the important Christmas trading period. Right now, the schedule is mostly filled with updates to existing games rather than new titles, but Nintendo does have some plans up its sleeve.

‘We have more titles planned for release in this fiscal year beyond the ones we have already announced, and we have accounted for those in the financial forecast,’ said Nintendo, but it is reluctant to set dates so long as developers are working from home. There is no shortage of characters and franchises to draw upon. We know a sequel to Zelda is on the way, and a new Metroid Prime title, we just don’t know when.

Therefore, the outcome of this financial year will largely come down to whether it can bring a solid set of new titles to market. Nintendo admits that it was unprepared for when its workers in Japan were forced to work from home as it ‘did not already have a remote development environment in place’, and it is still working out how to function properly in this new world.

Although it is ‘gradually gaining experience in assessing what can and cannot be done remotely’, it admits that impact on new releases ‘may potentially increase as the amount of time spent working remotely increases.’ Delays can be costly – Nintendo shares plunged last year when it announced the new Animal Crossing game had been delayed.

With this in mind, Nintendo could well be forced to rely more on its existing titles this year if there is a lack of new ones to push. This isn’t ideal as new titles are among the main reasons Nintendo attracts new gamers that decide to buy the console, but it does have a strong catalogue to keep users entertained. It has 27 games that have sold over a million copies, nine of which were made by external publishers.

Nintendo believes some of its older titles are yet to reach their full potential, such as Ring Fit Adventure, a game that mixes fitness with fun. The special controller needed for the game was in short supply after the game was launched last year, so Nintendo has started remarketing the title now that the issues are being resolved, ‘albeit gradually’.

Nintendo: how will it fare against the PS5 and Xbox Series X?

This year would be the worst time possible for Nintendo to take its foot off the gas considering Sony and Microsoft will both release their next generation consoles, the PlayStation 5 and the Xbox Series X, in time for the crucial holiday season at the end of 2020. Nintendo has always been the outlier of the three big players, and it does attract a different audience, but the improvement in power and quality of these new consoles could steal attention away from the Switch, especially if users aren’t kept compelled by new games. The company’s ability to not only retain users but continue to find new ones will be crucial in the latter half of this year and into 2021.

Having said that, Nintendo has proven it can hold its own by taking a very different approach to its rivals, and the general view is that its appeal shouldn’t be overly affected by the new consoles because they target such a different demographic.

Nintendo believes the Switch has much further to go. The company said in May that the console has only ‘just entered the middle of its life cycle’ and that it has ‘not changed our view that it is possible to aim for growth that is unlike the life cycle of any other hardware to date’. It does not intend to release a new console anytime soon, despite numerous rumours that it intends to launch a ‘Switch Pro’, a higher-end version of the console, in the future.

Nintendo’s mobile games and expansion into China disappoint

Nintendo’s strategy has evolved over the last year, and two previous catalysts for the company have now been put on the backburner and are not expected to produce the results that were initially promised.

Nintendo’s focus turns from mobile games to IP

The first is Nintendo’s mobile games. The company was hyping the potential of releasing new mobile games built around its famous characters a couple of years ago, and said it could be a $1 billion business, but there has been a change in management since then.

It currently has six mobile games available and whilst titles like Super Mario Kart Tour and Super Mario Run have been downloaded by hundreds of millions of people, Nintendo hasn’t proven it can successfully monetise them. Sales of mobile games and other income related to intellectual property (IP) climbed 11.5% in the last financial year, but that is slower than the wider market and it still accounts for a minor amount of overall revenue.

Nintendo’s view on mobile gaming has now changed drastically after the company warned ‘we are not necessarily looking to continue releasing many new applications for the mobile market.’ Instead of a potential money-spinner, Nintendo now views mobile games as a form of marketing – a way to introduce its characters and franchises to more people, who may then go on to buy a Switch or a new game.

For example, the number of people using Animal Crossing: Pocket Camp on mobile has risen in line with users of the Animal Crossing game on Switch and is helping introduce the game to more people.

Going forward, it is all about IP and finding new revenue streams from its catalogue of characters like Mario, Donkey Kong and others. In one sense, it is very much the tactic taken by Disney, which licenses out its brands to others. Nintendo has recently signed a deal for Levi Strauss to release a line of clothing dedicated to its characters and is working with Lego on a new Super Mario toy.

However, some will be wary of the step back from mobile gaming. Considering Nintendo’s niche is handheld gaming, the improvement in mobile games over the coming years – as well as that of streaming platforms like Google Stadia - could end up posing more of a threat to the Switch than the PS5 or the new Xbox.

Nintendo doesn’t expect much from expansion into China

Another area that previously had investors excited was Nintendo’s expansion into China. China is one of the biggest gaming markets in the world, and that fact is even more astonishing considering the country banned video games between 2000 and 2015 over fears they were negatively impacting children.

Those restrictions have been eased, but China still has much stricter rules compared to the likes of Europe or the US, especially over violent or sexual content. This was one of the reasons why investors were excited when Nintendo announced it was entering China as its line of characters are much more family friendly compared to most other major game makers.

It has teamed up with Chinese firm Tencent in order to gain access to the country and the Switch is available with three games at present, but Nintendo has cooled its expectations despite the huge opportunity on offer. ‘Sales in China did not yet account for a large amount in the results of the previous fiscal year,’ Nintendo said. ‘We do not expect sales in China to greatly impact the overall forecast for the current fiscal year either.’

China may be a huge gaming market and considered the last major opportunity left to tap by the big foreign players, but it is an entirely different market to the rest of the world. The majority of Chinese people will be highly unfamiliar with the concept of a games console, as most have shifted to PC and mobile gaming during the ban. The economics are far different too and leans more to a mobile model of ‘freemium games’ rather than making a one-off purchase on a console game.

Where next for the Nintendo share price?

Nintendo shares have reached a new high as investors hope Nintendo and the wider gaming industry will prove more resilient whilst the coronavirus is around. Although Nintendo has undoubtedly benefited from increased interest in gaming during lockdown, it has caused its problems and could cause more – most notably a slowdown in new games being released.

This financial year will not be as good as the last, so the significant increase in Nintendo shares over the past six weeks or so seems unjustified unless investors consider the guidance conservative or believe the stock represents a good place to stick their money during these uncertain times. Nintendo has no debt and is not short of cash. It can afford to continue investing in the business and satisfy shareholders. There is no threat to the dividend, although it will decline this year as it is tied to profit.

Nintendo: tough short-term outlook but strong long-term fundamentals

This financial year will be much tougher for Nintendo than the last and shares are likely to be tested since hitting their recent high. The demand for the Switch and its games are there, it’s a question of whether the company can meet it and deliver a steady flow of games.

The coronavirus has the potential to cause problems this year and it is clear that home-working and game development do not go hand-in-hand. Nintendo has already made it clear this will hit demand for consoles and games this year, and that this will feed through to its financial results and dividend. Furthermore, it will have heightened competition as new consoles are released while mobile games and game streaming sites continue to gain traction.

But Nintendo has solid prospects over the long term. It is financially fit and capable of generating cash, and its world renowned IP offers huge potential going forward. Some may fear the last financial year was the peak for console sales, but the company has not even started to pick at many of its classic franchises when it comes to games.

The potential of the games pipeline remains strong and Nintendo’s profitability will also improve as it shifts more toward higher-margin software from hardware. This year could end up being weak for releases, or it could surprise, but either way Nintendo has the titles it needs to bounce back strongly later this year or possibly in the financial year to the end of March 2022.

We know big name titles from the likes of Metroid Prime and Zelda are on their way, investors just need to gauge when they will come out as they could be trigger moments for shares.

Nintendo needs to get its own workforce back to the office in order to fully function, but once lockdown ends and people begin to return to their normal lives there is a risk that gaming will take a back seat as they go outside after months of staring at a screen. Indeed, spending on luxuries like games and computers are among the first to go when a recession comes around and people fall on hard times, and that could mean a troublesome few years for the big players.