Many investors have avoided Sankyo and other pachinko companies for a long time and for good reasons. The industry is considered risky due to several factors, including demographics, competition, and regulations.
Since my original report on Sankyo as of 1/26/24 (available in this site), the stock appreciated by around 20%. The stock was down by 7% on 9/19/24, punished by management’s disappointing guidance for Q2 FY3/25. Management did not change its guidance for the full year FY3/25 (sales -10% y/y and operating profits -16% y/y).
Nonetheless, over the long term, Sankyo has outperformed Topix as shown below:
Last 3-year returns:
Sankyo: +273%
Topix: +26%
Last 5-year returns:
Sankyo: +176%
Topix: +66%
Despite this outperformance, investor hesitation toward the pachinko industry is evident in its low valuation. Specific reasons for these low valuations include:
1) Population (players) decline
2) Competition:
Consumers have an increasing number of entertainment options available to them. The growing popularity of alternative forms of entertainment, such as video games, online streaming services, and other digital media is capturing the attention and spending of potential pachinko players.
3) Tight regulations:
I have discussed the history of regulations in the Pachinko industry report which is available in this site. I would like to emphasize that I did not initiate this discussion with a moral judgment about playing pachinko. Like any product, there are advantages and disadvantages. For instance, soy sauce, which pairs delightfully with sushi, can be lethal in excessive amounts.
4) Negative headlines:
4-a) In 2023, Gaia (located in Chuo, Tokyo), one of the top three hall operators, went bankrupt with group debts exceeding ¥110 billion.
4-b) Mr. Fujimoto, the former representative of Universal Entertainment resigned as a director on August 30/24, after the Tokyo High Court, found him guilty of authoring the transfer of approximately $43.5 million from Universal Entertainment without proper justification and failed to adhere to the company’s internal protocols.
These news reports heighten investor concerns about which companies might be next to face challenges. Therefore, it will be crucial to focus on companies that will be able to adapt and thrive in this evolving landscape.
5) Smart machines’ success
Some argue that manufacturers are temporarily thriving due to the special demand created by the deregulation of smart gaming machines that enclose balls or medals inside the devices. The key point is that the standards for gambling inducement have been set more leniently than before to promote introduction. Therefore, the installation of smart machines may slow down once the initial excitement wears off.
My counterargument:
Some of the challenges listed above—population decline, competition from other forms of entertainment, and sales volatility—apply to video game developers. Nowadays, pachinko and pachislot machines incorporate video game and anime content to attract younger players, blurring the lines between video games and pachinkos.
However, video game stocks are trading at much higher multiples.
For example,
Square Enix: 25x (High dependence on two largest RPG franchises/Dragon Quest and Final Fantasy)
Koei Tecmo: 16x (a smaller company)
Therefore, we can conclude that the significant discounts on pachinko stocks are due to tight regulations and headline risks. These risks cannot be denied and are unlikely to disappear. Thus, I propose investing in long-established players with solid balance sheets who have managed to grow despite tough regulations. For instance, Sankyo’s sales of pachinko machines exceeded 30%, achieving the highest market share for the second consecutive year.
I would love to hear your opinions against my counterarguments.
Even with ~70% appreciation for the past 12 months, Sankyo is trading at 3/25 expected PE at around 12.5x. However, cash and marketable securities of ¥196 Bn accounted for about 40% of the market cap ~¥539.6Bn, yielding cash adjusted P/E of 8x. The dividend yield is already high at 3.85%. With its solid capital ratio of 86%, the company has many options available to fund its content growth and equipment investment while raising dividend payout.
Below is the financial highlights for FY3/24 and Q1 3/25
FY 3/24 results:
For the whole industry, smart pachislot machines continue to produce hit titles, driving the overall performance of the pachislot market. In contrast, smart pachinko machines have seen only limited success, with hit titles remaining few.
However, Sankyo has introduced 10 new titles and achieved significant success in the pachinko business, led by flagship series machines such as “Fever Mobile Suit Gundam SEED” and “Pachinko Shin Evangelion Type Rei”.
In the pachislot business, the company has actively promoted the transition to smart machines. Starting with the industry’s fastest introduction in November 2022, they have introduced 5 new titles.
As a result, net sales reached ¥199.0 billion (a 26.6% increase y/y), operating profit was ¥72.4 billion (a 23.9% increase), and net profit was ¥53.7 billion (a 14.7% increase).
The rising contribution of Pachislot is evident in that it accounted for 16% of total sales in FY3/24 vs. 14% in FY3/23. In operating profits, it accounted for 21% of total OP vs. 16% in FY3/23.
Q2 FY3/25 Guidance on 9/2/24
On 9/19/24, the company released its guidance for 1st H FY3/25, as the outlook for deliveries of their main pachinko and pachislot machines up to the end of 9/24 was largely finalized.
The main points of guidance:
The number of pachinko machines sold is expected to decrease vs. the same period of FY 3/24.
However, “eFever Mobile Suit Gundam Unicorn Returns -The White Unicorn and the Black Lion-“, released in 8/24, has become their first hit title as a smart pachinko machine. Sankyo expects this to provide momentum for the wider adoption of smart pachinko machines going forward.
Pachinko machine sales volume forecast: 83,000 units (vs. 167,000 units last year)
In the pachislot business, the company significantly increased sales volume by releasing 3 new titles, including “L Pachislot Senki Zesshou Symphogear Song of Justice”.
Pachislot machine sales volume is expected to be 81,000 units (vs. 48,000 units).
Total sales guidance: ¥90,000 Million (-29% y/y)
Operating profits: ¥35,000 Million (-30% y/y)
Net income: ¥25,000 Million (-31% y/y)
In the full-year guidance for FY3/25, there are no changes to the numbers released in 5/24.
Total sales guidance: ¥180,000 Million (-10% y/y). The first half achieved 50% of the full year number.
Operating profits: ¥61,000 Million (-16% y/y). Achieved 57%
Net income: ¥42,000 Million (-22% y/y). Achieved 60%
Summary:
While FY3/25 will see a decline in sales and profits against a very strong FY3/24, sales are performing as planned. As the first hit Smart Pachinko title (eFever Mobile Suit Gundam Unicorn Returns) gains popularity, the upside can be possible.