I wrote about Sony (NYSE:SNE) in October last year and details of the company’s growth perspective can be read here.
The company is well-positioned in the growth areas of Gaming, Music and Imaging & Sensing Solutions. However, in the short term, its Films and Finance & Insurance divisions will no doubt be badly hit with a negative impact on earnings.
Its strong balance sheet should enable it to weather the storm and emerge stronger than before relative to the market as a whole. Its enlightened focus on investment in production capacity should stand it in good stead. It will benefit from the intrinsic long-term outlook of the Japanese business, in contrast to the short-term gains many Western companies prefer. Its vertical integration strengths are a very positive factor.
Sony had reported excellent Q3 results which can be seen in detail here. All eyes now though will be on Q4 (which is for the period up to March 31). These are due to be released on April 24.
Many well-established companies around the world will go by the wayside in these unprecedented times. That will give advantages long term to the survivors. There seems no doubt Sony will be one of these. Figures from Charles Schwab (subscription required) verify this.
Its short-term debt is very healthy with a Quick Ratio of 0.76 and a Current Ratio of 0.86. Long-term debt to equity is only 0.15. This is despite the company’s quite substantial investment in future production capacity. The company has enjoyed increased free cash flow despite its large capex. It has over US$5 billion in cash and equivalents. A similar U.S. company might well have spent much of that on stock buybacks.
The 3-year stock chart is illustrated below:
That just reinforces how well the company was doing before COVID-19 struck.
It is very much a valuation play as I have detailed before. Right now valuations are hard to assign due to the day-by-day swings in stock prices.
With such a diversified portfolio it is hard to define exactly what should be the industry average with which to compare. The ratios are very healthy no matter what you compare them with.
It is no surprise that analysts like the stock. Oppenheimer recently began coverage with a Buy rating and price target of US$69. The average analyst rating is Buy.
Finance & Insurance Division
The company had forecast that this division would produce 17% of revenue and 16% of profits in 2020. The business is focused on Japan and the country has been hit like every other by COVID-19. The economy will be further hit with the cancellation of the Tokyo Olympics. Sales of life insurance policies will decline as individuals are hit in the pocket. Sony Bank’s investment portfolio will decline substantially but presumably recover when world stock markets recover.
Sony seemed to have pulled their previously lacklustre Pictures division around last year. “Once Upon a Time in the West” and the latest “Spiderman” franchise were big revenue generators. Other Marvel superheroes and the “Jumanji” series should prove profitable future franchises.
This year has seen an almost total collapse of movie-going worldwide. The new Bond movie has been delayed from April to the end of the year. The much anticipated “Peter Rabbit 2:The Runaway” has been delayed for 5 months from its planned March release.
As discussed at the Q3 analyst call, management is optimistic about the Game Show Network business, which is included in the Pictures division. It seems logical to presume that this division will bounce back in time, but there will be a big hit to 2020 revenues. In the first 9 months of the current year, the division represented about 10% of revenue. This will decline as a proportion in 2020.
This is a core strength and advantage for Sony. Gaming provided about 24% of its earnings in the first 9 months of the financial year. Its PS4 console has dominated for years over the Xbox of Microsoft (MSFT). There is a quite slow move away from console gaming to online gaming and consoles will probably remain important for years to come. In the worldwide gaming market worth perhaps US$130 billion, only about US$800 million so far belongs to the cloud gaming sphere.
The new PS5 is due to release late this year for the holiday season. It is not known yet if this will be delayed. If it is, then so probably will be the competing new Microsoft offering. There are serious disruptions to the supply chain of chipmakers. Sony’s biggest contract manufacturer Foxconn (OTCPK:FXCNF) is already struggling to meet demand for a variety of products, notably for Apple (AAPL). Various reports have come out as to the form factor of the PS5. It seems likely it will include an LCD display and a heart rate sensor and still have a disc drive.
The company’s cloud gaming offering PlayStationNow had been criticised by some observers. It does, however, now offer over 500 games.The company probably moved quite slowly because it was doing so well with its console business. Late last year, however, Sony ramped up its offerings and cut its pricing. This was probably in response to competition from Microsoft and Nintendo (OTCPK:NTDOY) and upcoming competition from Alphabet (GOOGL) (GOOG) and Amazon (AMZN).
Virtual reality is an area where Sony maintains a lead through its ability to tack on to its PS4 console and negate the need to buy expensive ancillary computing power. Much was made of the new “Oculus” VR offering last year from Facebook (FB) but that seems to have gained limited traction. Some have speculated that COVID-19 will indeed encourage the take-up for VR, both in commercial and personal applications.
Meanwhile, gaming remains one of the few healthy areas as the world moves increasingly to a “stay at home” economy. A previous article here lays out the long-term growth that gaming is likely to achieve over the next few years. Short-term gaming is likely to increase its proportion of Sony’s revenue because of COVID-19.
Imaging & Sensing Solutions
This has been an under-appreciated asset for the company. It is becoming the jewel in the crown as much as the gaming division. The company is thought to be targeting this division rising from 20% of profits to 30% of profits by 2025.
Sony is believed to have an over 50% share in the image sensor business for mobile phones with Apple and Huawei as major clients. Samsung (OTC:SSNLF) has been its major competitor. Sony has been ramping up capacity at its present plants to meet soaring demand for its products. There will be a short-term decline in smartphone sales around the world, but this will partly represent an opportunity for Sony to match supply with demand. The company has a major new plant in Nagasaki due to come on stream in April 2021.
Substantial investments in CMOS sensors should strengthen its position in a business where the barriers to entry of new competitors are quite high because of the high costs involved. However, the company may face increasing competition from South Korean company SK Hynix (OTC:HXSCL) which is shifting some production from DRAM to CMOS.
This division impacts positively on other Sony products and emphasises the company’s great strengths through its vertical integration. The fact that Third Point wanted to sell the division to enable short-term profits for shareholders illustrates how little Dan Loeb appreciates Sony’s core strengths. If Loeb had had his way, Sony would have returned cash to shareholders, had a less diversified company, and seen more pressure on its balance sheet as COVID-19 strikes. What Third Point saw as weaknesses are today great strengths.
Music is a strong secular growth business. The industry has transitioned successfully and is increasing revenues as the switch to a streaming model continues.
Sony has wisely invested further to strengthen its already strong position as the world’s leading music publisher and second-largest revenue generator from streaming. My previous article detailed much of this. That included its buy-out of the balance of EMI it did not already own. It has retained a profitable stake in Spotify (SPOT) after selling part of its stake for US$750 million. This division is likely to do well short term in a “stay at home” economy. In the first 9 months of the financial year, the division represented about 10% of revenues. This is likely to increase quite substantially as a proportion of total revenues in 2020.
Sony’s image sensor division and wide-ranging Internet of Things offering should enable it to ride the wave of future developments. An example of this is its well-known Aibo robot dog pictured below:
This keeps developing. It is able to interact with people and also with electronic items in the home through its ability to learn and interact through AI.
Drones and medical devices is another strong growth area in which Sony has a promising position through its expertise in image sensors and cameras.
These new product areas are centred around the “Startup Acceleration Division” which I detailed in an article last year.
The Mobile Communications unit has been the one last and perennially loss-making unit in the company. Following substantial cost reductions, the unit did actually make a small profit in Q3 even though sales declined 16% year on year. There seems to have been some limited success with its new” Xperia 5″ phone. The company has promoted this as a gaming phone with remote access to the PS4 and ability to play games such as “Fortnite.” Despite the excellent reviews, the “Xperia” range continues to fail to gain real traction in the upmarket sector dominated by Apple and Samsung.
The company announced a new 5G phone in February, the Xperia 1 II. There is talk of a revolutionary foldable and rollable phone and of new large-size OLED phablets. Many observers have said Sony should drop the division. They fail to appreciate its key role in Sony’s Internet of Things comprehensive offering. It is well worth keeping as long as big losses do not return.
Home Entertainment & Sound division will no doubt find manufacturing operations and retail sales hit. For instance, it was reported recently that two TV plants in Malaysia were temporarily closing because of COVID-19. The company has developed a successful policy whereby revenues decline but profitability increases.
Sony’s strong position in a range of growth markets should place it in a very strong position in a post COVID-19 world.
As I wrote previously, it had fought off the misguided efforts of Third Point to break up the company for short-term profit. Many U.S. companies are now being seen as frittering away money in share buybacks and being short of cash in a crisis economy. Sony has invested for the long term.
Its strength in certain “stay at home” categories should limit the shortfalls in other areas affected by COVID-19. I see it as a definite long-term Buy. When investors want to dip back into the market is of course a personal decision as to how long they think COVID-19 will cast a shadow over the world’s economy.
Disclosure: I am/we are long SNE AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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