Is Nintendo Bouncing Back? September 30, 2015 Analysis

Authors Notes: Because of the technical nature of this article, a summary is provided at the end.  Also, parts of this article are my analysis and opinions.

Fans often make assumptions about Nintendo’s financial performance from saying they are doomed or posting images of company executives with devices that print money. However, these are just assumptions  Fans have recognized the poor performance of the Wii U and the 3DS but also indicate that the systems are doing better and that Nintendo is on the up and up. So let’s look at Nintendo’s September 2015 financial results and the briefing to see how Nintendo is actually doing and see if the 100 year-old Japanese game publisher is bouncing back.  (Author’s note: because Nintendo is a Japanese company, all currency will be expressed as yen unless stated otherwise)     

Earnings    

Net Income declined from  ¥14,297 million as of September 30, 2014 to  ¥11,452 million as of September 30, 2015.  On the surface, it seems Nintendo has done worse since the same time last year, but this isn’t necessarily the case. Profit is  simply the culmination of all income and expenses. This can include income and expenses that may not be related to Nintendo’s core business and may not be recurring. Instead, let’s look at Operating Profit, which is income from Nintendo sale of video games.  Operating profit increased from negative  ¥215 million to  ¥8,977 million.  This is due to a 19.1 percent increase in sales, from ¥171,399 million to ¥204,182 million.  Essentially, Nintendo has sold more games, and operating profits therefore increased. So why did Nintendo’s profits decline?

In order to answer this, we need to adjust earnings.  What does this mean? During the course of a year (or in this case, six months) a company may do things that are non-recurring but result in income or expenses.  For instance, if a company sells a piece of equipment for more than it’s on the books for, then that company records a gain and their income goes up. But a company can’t sell the equipment again for profit next year, can you? Of course, the answer is no. So, to have a fair comparison, we try to eliminate those transactions or events that result in non-recurring income and expenses.  Below is a table which summarizes these changes.

*I did not remove/add gain and losses on the sale of non-current assets since they were not significant.

So, why were the above items removed or added? Generally, gains on the sale of anything are non-recurring. These are assets that are not inventory (such as games or amiibo) but other assets Nintendo has (such as equipment or bonds). Nintendo can not sell the same asset twice, so it is removed. But what about “Other?” Well, Nintendo seems to have made a change to their income statement. In the 2014 six-month release, Nintendo had a section titled “Foreign exchange gains” totaling ¥15,587 million. This is essentially the benefit from selling products in other counties with other currencies. Without going into too much detail, a gain usually happens when the customer is invoiced one day and then pays another day with a different exchange rate. Videogames are unique as they have a standardized price. Although that price is the same in the country it’s sold in, the exchange rate of the currency is not. So, if Nintendo sells a game in Britain, it would have a set price in pounds. But, if the value of the pound increases relative to the Yen, then Nintendo will have more Yen for the same amount of pounds. Conversely, if the value of the pound decreases relative to the Yen, Nintendo could see itself losing money. Exchange rates can be volatile, so it’s best to adjust them out to arrive at a more sustainable earnings picture.

Reasons for the Improvement

Overall, it appears Nintendo’s profits from core business activities have improved, despite Net Income being lower. As stated above, the improvement is primarily due to an increase in sales. Chief among these are Super Mario Maker and Splatoon. As discussed in Nintendo earnings release, Super Mario Maker, released in September, sold 1.88 million units worldwide and Splatoon, released in May, sold 2.42 million units worldwide. For the 3DS, Animal Crossing: Happy Home Designer sold 2.02 million units worldwide. Interestingly enough, sales increased in Japan and the US (“The Americas” in Nintendo’s report) but actually declined slightly in Europe. The improvement in sales is driven by the Wii U as hardware sales increased by 70,000 and software sales increased by 2,970,000. Keep in mind that as of September 30, 2014, Super Smash Bros for 3DS was released as was Mario Kart 8, both titles that have sold extremely well. Given that, the current sales are impressive.

Charts showing the improvement of software sales in Japan, driven by Splatoon and Super Mario Maker.

During the Semi-Annual Financial Results Briefing, President Tatsumi Kimishima noted the improvement in Wii U software sales and hardware sales in both Japan and overseas. As he notes, although sales improved in the US and Europe, the sales improvements were not as strong as in the Japanese market. Splatoon was a hit in Japan as the game sales totaled 905,000 a week prior to the briefing and is expected to surpass one million units. It should also be noted that Splatoon did exceptionally well between the months of July through September selling 800,000 units. Super Mario Maker has done exceptionally well selling 1,880,000 since its release in September.

amiibo, launched in 2014, have been a big success story for Nintendo.

One of Nintendo’s recent success stories has been amiibo. Nintendo’s toy-to-life line has done exceptionally well, even having an unexpected stock shortages early in 2015. President Tatsumi Kimishima noted that amiibo sold 10.5 million units in the previous fiscal year (ending March 31, 2015), and sales have more than doubled in the last 6 months with approximately 10.60 million in sales. It is likely that sales have increased as there are more amiibo. As President Tatsumi Kimishima stated in a TIME interview “What we’re seeing instead is that the amiibo are being picked up more as a collection item at this point, rather than, say, as an interactive item with software.” It’s not unusual to see collectors with tons of different amiibo. So, the increase in sales may be a result of collectors expanding their collection rather than more consumers latching onto amiibo. Thus, the increase in sales would be from more amiibo offered as compared to the prior fiscal year when they just launched. Regardless, how has this impacted Nintendo’s sales during the year? At $13, totals sales would be $137 million (or ¥16,686 million). This accounts for half of the increase in sales. So while amiibo have had a significant impact on the increase in sales, but it was not the sole reason for the increase.

The other improvement was download sales. Download sales totaled ¥21 billion which is double the sales of the first-half of the previous fiscal year. President Tatsumi Kimishima indicated that the improvement was mostly due to the sales of add-on content. Interestingly, he mentioned that sales in the second quarter were less than the first quarter. This may be due to the release timing of Super Smash Brothers DLC. He indicated that Super Smash Brothers for 3DS was the best performing title for add-on content and Super Smash Brothers Wii U was the third best performing title. Since Mewtwo, Lucas, Roy and Ryu were all released in the first quarter (March 31st 2015 through June 30th 2015), this likely resulted in weaker download sales in the second quarter. The download sales would account for a third of the improvement in totals sales, assuming Cloud and any other characters are released by December.

Charts showing the games with the best sales for downloadable content

Overall, over 80 percent of the improvement in sales was due to amiibo sales and due to downloadable content. Thus, the improvement in Nintendo’s earnings is mostly from introducing new products. Nevertheless, the rest of the improvement is due to increase in traditional game sales, which is lead by Splatoon, Super Mario Maker and Animal Crossing: Happy Home Designer.

Future Outlook

image source: http://www.chartingyourfinancialfuture.com/investing/quote-of-the-week-marketing-timing/

So, how will the rest of the fiscal year look for Nintendo? First, it should be noted that Super Mario Maker’s sales only reflect one month. Thus, sales may be higher in the third quarter. Also, more Smash Brothers DLC is likely coming in December, so third quarter download sales will likely be higher than the previous quarter. amiibo sales may have been increasing due to more amiibo being available rather than more consumers buying into amiibo. Nevertheless, it appears Nintendo is trying to improve the stock issue with many retailers receiving restocks of amiibo. amiibo sales in the third quarter will be dependant on the sale of the Animal Crossing amiibo. The main title these amiibo have been used in, Animal Crossing: amiibo Festival, has not been well received with a Metacritic score of 44 out of 100, so sales may be dependent on collectors rather than consumers who buy the amiibo to use in game.

The greatest concern for the 3rd quarter is Nintendo’s video game line-up. Nintendo’s line-up appears weak with several spin-off games such as Animal Crossing: amiibo Festival and The Legend of Zelda: Tri-Force Heroes. I don’t expect these games to be blockbusters, and, as such, Nintendo’s holiday sales will be more dependent on already available titles like Splatoon, Super Mario Maker, and Super Smash Brothers. Also, amiibo were released in the third quarter of the previous fiscal year; thus, third quarter sales may not be strong as compared to the previous fiscal year, especially when amiibo were a significant reason for the improvement in earnings through the second quarter. Moreover, the third quarter of 2014 was filled with numerous heavy-hitting titles include Super Smash Bros for 3DS/Wii U, Mario Kart 8, and Pokemon Omega Ruby/Alpha Sapphire. Nevertheless, it appears Nintendo is off to a good start as the Wii U was the best selling item on Target.com during Black Friday.

Conclusion

Nintendo seems to be in better shape, but they aren’t out of the woods yet. Super Smash Brothers DLC will end, limiting income from download sales. amiibo have done well, but Nintendo will need to ensure that there are enough amiibo-compatible games. Nintendo has not produced many amiibo centered games in the way Activision-Blizzard has with the Skylanders games. Overall, it is ultimately the games which will make or break Nintendo’s earnings. Nintendo will need to deliver more blockbusters if they truly wish to return to Nintendo like profits.

Summary

• Net Income declined from  ¥14,297 million as of September 30, 2014 to  ¥11,452 million as of September 30, 2015, but Operating profit increased from negative  ¥215 million to  ¥8,977 million.
• When removing non-recurring items, Net Income for the second quarter improves significantly. Earnings from the second quarter of 2014 were enhanced by foreign exchange gain.
• Wii U software sales increased by 2.97 million as compared to the second quarter of 2014, primarily from the release of Splatoon and Super Mario Maker.
• amiibo sales increased, but it may be due an increase in amiibo available as sales of amiibo come primarily from collectors.
• Download sales totaled ¥21 billion which is double the sales of the first-half of the previous fiscal year. Sales declined from the second quarter from the first, likely because most of the new Smash Brothers characters were released in the first quarter.
• amiibo sales accounted for about half of the improvement in sales and download sales accounted for about a third of the improvement. The rest was from an increase in game sales.
• Third quarter sales may improve with Super Mario Maker having a full quarter, amiibo sales, and Smash Bros DLC.
• On the other hand, sales in the third quarter of 2015 may be lower than 2014 due to amiibo launching in the same quarter and the amount of heavy hitting titles released in the quarter.