I have a Sell rating for Capcom Co., Ltd. (OTCPK:CCOEY) (OTCPK:CCOEF) (9697:JP) stock. My view of Capcom has turned negative, and my rating for the stock is downgraded from a Hold to a Sell. I expect operating profit misses for the company in the quarters that follow, and I also have an unfavorable opinion of Capcom’s prospects for the long run.

Readers can deal in Capcom’s shares traded on both the Tokyo Stock Exchange and the Over-The-Counter market. The three-month average daily trading values for the company’s OTC shares and Japanese shares were $0.2 million and $35 million, respectively based on S&P Capital IQ data. Investors can buy or sell the company’s Japan-listed shares with US brokers like Interactive Brokers.

Anticipating Negative Surprises For CCOEY In Subsequent Quarters

In my earlier May 31, 2024 update, I noted that “I am worried about a potential FY 2024 (YE March 31, 2025) operating income miss for Capcom” because of ” declining margins for (older) games” which are discounted and the “dependence on new games.”

CCOEY’s latest quarterly performance as disclosed in its earnings presentation slides and the change in the market’s expectations of the company’s full-year results according to data sourced from S&P Capital IQ have validated my concerns.

Operating income for Capcom dropped by -46% YoY to JPY 12,889 million in the first quarter of fiscal 2024 (April 1, 2024 to June 30, 2024). This was -2% below the sell side’s consensus estimate of JPY 13,095 million. Also, the analysts cut their full-year FY 2024 consensus operating profit projection from JPY 72,012 million to JPY 70,006 million in the last three-month period.

At the company’s most recent Q1 FY 2024 earnings briefing, an analyst highlighted that Capcom’s “growth of catalog title unit sales slowed despite discount promotions.” In response, CCOEY mentioned that “we will continue our efforts to find appropriate price ranges” to “drive sales.” The company also emphasized at the first quarter analyst call that it “will continue to explore optimal promotional measures for each country and region to increase awareness.”

Based on the management’s latest comments, it is likely that CCOEY will continue with its approach of discounting some of its older games. But this strategy of lowering the pricing for certain mature games didn’t work that well in the recent quarter. The company’s unit sales fell by -29% YoY and its operating margin contracted by -11.3 percentage points YoY in Q1 FY 2024.

On the other hand, Capcom appeared to have a cautious view of its newly launched games and the investments required to support these new launches.

CCOEY’s new game titled “Kunitsu-Gami: Path of the Goddess” was introduced to the market in late July. The company noted at its first quarter results briefing that “Kunitsu-Gami: Path of the Goddess” is “a completely new IP” for which “it is necessary to increase communications regarding the appeal of the game.” This seems to indicate that Capcom is keen on growing its marketing investments to boost the sales of new games, and this might pose downside risks to its future operating profitability.

But the market still seems too optimistic about CCOEY’s performance this year. As a comparison, the current consensus FY 2024 operating income forecast of JPY 70,006 million is 9% higher than the company’s guidance of JPY 64,000 million. In my view, the chances of negative surprises associated with Capcom’s future quarterly results are reasonably high.

Company Faces Significant Challenges In The Mid-To-Long Term

Looking beyond FY 2024, the outlook for Capcom remains challenging. CCOEY has a significant focus on video games played on PCs (accounting for 52% of its Q1 unit sales), and this puts the company in a difficult position to compete in the future.

According to PricewaterhouseCoopers’ or PwC’s Global Entertainment & Media Outlook 2024–2028 report, the worldwide gaming market share for traditional video games is forecasted to decrease from 28.6% for 2023 to 21.4% in 2028. According to PwC’s research, social or casual games are expected to gain market share at the expense of traditional video games (like Capcom’s Monster Hunter series) in the years ahead.

On the other hand, it won’t be easy for Capcom to grow its sales of PC games in emerging markets. The company acknowledged that “consumers will need a PC with specs (specifications) as good as the latest consoles” to “comfortably play the (company’s) latest titles released in the past few years” as per its Q1 FY 2025 analyst call commentary. The purchasing power of consumers in emerging economies is relatively lower than that for developed countries. This means that a higher proportion of gamers in these markets won’t likely have sufficiently good personal computers to play CCOEY’s most recent games.

Variant View

Under specific scenarios, Capcom’s business and share price performance might exceed expectations.

One scenario sees Capcom’s new game titles introduced to the market becoming much more popular than what the market is anticipating.

Another scenario has CCOEY expanding its presence in emerging markets at a faster pace by focusing on new games played on non-PC formats and optimizing its marketing strategies successfully.

Conclusion

Capcom’s valuations are unappealing, and its outlook for the near term and long run is negative. This explains my bearish view on the name.

Capcom is now trading at 15.7 times consensus next twelve months’ EV/EBIT, while the company’s consensus FY 2023-2028 EBIT CAGR estimate is +12.5%. These metrics were sourced from S&P Capital IQ.

A stock is judged to be overvalued, if the company’s earnings multiple exceeds its earnings growth rate. This is the case for CCOEY, taking into account its EV/EBIT metric and EBIT CAGR forecast.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.