A Better Value in Japan: Nintendo

Jun. 9.11 | About: Nintendo Co., (NTDOY)

Out of all the Japanese stocks hit recently by the earthquake and a rising yen, few have been knocked down harder than Nintendo (OTCPK:NTDOY). Shares were down 6.8% today and the stock now sits at a 52 week low. Nevertheless, Nintendo has significant value and is selling cheap for three reasons. The company sits at the bottom of an earnings cycle, the market underestimates the core value of its gaming franchises and Nintendo's sales are less susceptible to the damage of earth quake than its neighbors.

The first value driver in Nintendo's favor is that its recent earnings reports have been at the bottom of the company's product cycle. They have currently brought in their new portable product the Nintendo 3DS just recently on March 27, 2011. It is the first truly 3D video game system not to require any glasses. Sales at launch broke handheld records. They have slumped a little since, but will pick once Nintendo releases some more quality games to hook in buyers. They also recently announced their next generation home console Wii U. New console sales and the game and peripheral sales boost that come with will be a big boost to Nintendo. Critics within the gaming industry are critical of the U, but similar sentiment was occurring during E3 2005 with the Wii's release. As showcased by the Wii and more recently by the popularity of Zynga, hardcore gamers no longer control the video game market. Nintendo's Wii U offers a new experience with a touch screen controller and a variety of other features unique to a home console. Pitching new innovative ways to play video games have replaced the demand for simply more powerful graphics and bigger game budgets and Nintendo aims to capitalize on this trend.

More importantly, competitors Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) do no plan on releasing a next generation to the Xbox 360 or Playstation 3 for at least another five years. Historically those who enter each generations console wars first are big winners and often hold onto the dominant market share. However, with a five year ahead start, Nintendo will have its position in the market well entrenched (and third party producers used to their software design platform) before Sony and Microsoft have a chance to effectively counter.

In addition, Nintendo has a host of well established gaming franchises that nearly guarantee high sales upon each release. These brands include the Mario Brothers, Pokemon (which carries their handheld market), The Legend of Zelda, Metroid, Wii Sports/Fit, F-Zero, Star Fox and a motley of other unique franchises and spin offs. These games sell well among all age groups and add legitimacy to any console the company releases.

Unlike fellow Japanese companies, Nintendo is not dependent on domestic sales or production for success. Nintendo manufactures its hardware in China and none of its research facilities were damaged by the recent earthquake. Nintendo also is very internationally diversified. Less than 10% of sales come Japan, so earnings mainly come from North America, Europe and emerging markets.

These three factors have depressed Nintendo's earnings and stock price artificially over the past few quarters and I expect once this market pullback subsides that it is excellent time to buy. Sales for the new 3DS will appear in October's Q2 earnings report and I expect a pleasant surprise when those come out. If the market or Nintendo's technicals do not turn around any time soon, then wait one to two months before the Wii U comes out. I expect the stock to skyrocket then similar to what happened with Wii sales in 2006. Despite recent setbacks, Nintendo is a profitable company with a higher ROIC than competitors (or at least their gaming divisions). Sony and Microsoft Overall, Nintendo is down but not out. As long as they either embrace third party developers or release a large set of new games with the Wii U, I expect Nintendo to outperform other gaming stocks in the long run.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.