Nintendo: Game Over

Avid readers of SmartGuyStocks know that Nintendo (NTDOY.PK) has been one of our favorite stocks over the past year. NTDOY is the only stock I have recommended twice. The company has delivered two of the most exciting products in the world: Wii and DS. However, I believe price appreciation is limited for the following reasons: skyrocketing shipping costs, the weak dollar, and the current point in the console cycle.

First, let me preface my comments by saying NTDOY is still one of the best companies in one of the hottest sectors in the world. If the global economy was steamrolling, I would hang on to NTDOY through the coming holiday season. Unfortunately, my wish is not the economy’s command. Rather than fight reality and stubbornly hold my shares, I am willing to take my extraordinary gains and accept that my risk-reward ratio has diminished.

Although many shareholders will focus on the positives at Nintendo, headwinds are gaining strength. As oil costs levitate, shipping costs perform the same miracle. These costs eat into NTDOY margins for both manufacturing and distribution. Moreover, the dollar continues its celebrity makeover as toilet paper. This will continue to diminish the value of building in yen and selling in dollars.

Thus, the great irony of globalization (i.e., foreign production is cheaper) begins to mature. The forces in the global oil and currency markets are stronger than those in the growing video game space. And until something changes, these costs will limit upside in NTDOY.

Lastly, the easy money has been made in the current console cycle. Those who remain in shares are playing chicken with the inflection point of the cycle. Some time in the next 12-18 months I expect Microsoft (MSFT) and Sony (SNE) to start introducing exciting concepts for their next generation consoles. These glossy press releases will create signs that the current cycle is in the latter stages.

Once that happens, analysts and investors will start to look ahead. And once that happens, doubt will arise as to whether NTDOY will repeat its success in the future. If you are still holding shares at that point, you will be very disappointed to see Nintendo the company still minting money while NTDOY the stock discounts for the great unknown of the next console cycle.

I do not aim to find the absolute high and low of a cycle. Rather, I seek to capture the easier money when companies are in stride during their climb or descent. That’s why I have not made many picks since the market has traded in a choppier manner. I prefer shorts and puts when things are falling hard, and buys and calls when they are rising in a healthy environment. Occasionally I will offer a short-term trade that contradicts the macro environment, but those who follow my picks will make most of their money in the sweet spot of each cycle. My one-year track record on SmartGuyStocks validates this strategy.

On a technical note, NTDOY peaked in the high 70’s and has not been able to push back. This is more evidence that the macro environment has great control over NTDOY shares. I held my shares during the decline from the peak because I believed the stock had a chance to bounce back and charge ahead for another leg up. Despite excellent growth and earnings, the stock has not made new highs. Therefore, I believe we may be witnessing the best price for NTDOY we will get as the hype for Mario Kart and Wii Fit bring optimistic buyers back to the trading floor.

Of course, the economy could improve later this year, but I do not take my economic analysis from the White House. From where I sit, it’s game over for Nintendo’s risk-reward ratio.

Comments

[robert.bohrer]

Excellent article, agreed on all points. I bought NTDOY when the Wii came out at $27 and sold at $63 a few months back. I'd love to pick it back up again, but unfortunately, the problems brewing mean the risk/reward ratio isn't nearly as enticing as it once was.

[IAMREPUBLICNnIAMPROD67958]

YEAH MAN I FEEL YA I BOT MINE BAK IN THE DAY THO AND IT HAS SJW DON SINCE DEN AND IT HAZ NO WAY OR ECONMIES GET BIGAR

[marce]

You miss some points. How about the possibility of Nintendo of introducing a DS 2? How about the increased pool of consloes resulting in more software with greater margins being sold (with lower fuel related shipping costs). How about a next gen wii coming out? How about the suprise titles for this coming holiday How about wii fit opening the market even more. How about wiiware and sales to Korea and China? How about greater integration between ds and wii. It seems that these factors were not considered in your analysis. Also, look at the yen to dollar Now 104- moving in the right direction. You are accurate that the $78 high has not been approached as of late but look at the overall stock market--most companies are below their highs.

[SmartGuyDH]

As predicted three months ago:

July 30, 2008 - Bloomberg: Nintendo plunged 8.7 percent to 52,600 yen, the most since Jan. 28 and the biggest drag on the MSCI Asian gauge. The world's largest handheld game player maker said first-quarter operating profit rose 32 percent to 119.2 billion yen ($1.1 billion) and maintained its full-year profit forecast.

There was ``some expectation'' that the company would raise its full-year earnings projections, said Jay Defibaugh, a Tokyo- based analyst at Credit Suisse Group, in a report yesterday. ``We view 1Q results as in line to modestly disappointing.''