Sony: Good Value + Low Price = Buy (NYSE:SONY)

Investment Thesis

Sony (NYSE:SONY) is a high-quality value stock, and we believe it is severely undervalued by the market. The company’s business is broadly diversified and has proven to be resilient amidst current macroeconomic challenges. The company holds leading positions in several markets at once, it has strong pricing power and loyal audience. We give Sony Buy status at current prices.

Leadership in the gaming and electronics market

Sony is a widely diversified business. The company has six major divisions producing completely different products, but the most recognizable is the PlayStation console.

Video games have become a sought-after leisure activity and are popular among children and adults alike. Previous generations of PlayStation have greatly outpaced their competitors due to the large list of exclusive games, according to VGChartz. Competition in the video game market has increased significantly with the advent of the next generation of consoles (PS5, Xbox One/X, Nintendo Switch). There are far fewer exclusives, and many games have been released on alternative platforms.

Nevertheless, PS5 consoles remain in high demand, even though they are in a price range higher than their closest competitor XBOX. With almost 30 years of PlayStation presence in the market, Sony has managed to build up a very large loyal customer base, so we think the trend will persist in the future. Even with the loss of some audience in favor of Microsoft or Nintendo, PS5 sales will remain strong.

An important part of the company’s strategy is the acquisition of game studios and work on its own projects. At the same time, Sony has large sales volume, for example, in the first half of 2022 games from Horizon and Gran Turismo franchises ranked 4th and 7th by sales in the U.S., according to NPD Group.

We are optimistic about the future of Sony. The company has already implemented many successful projects, several famous teams are working under its wing, so Sony is highly likely to maintain its dominant position in the video game market.

The current situation leaves much to be desired, as the exit from the pandemic still manifests itself in a decrease in MAU and user spending on content, but we expect the activity to recover in 2023-2024 with the release of new games, which will have positive effect on revenue.

CMOS is the rough diamond

By associating Sony more with the home electronics and gaming industries, investors omit a very interesting segment – Image & Sensing Solutions.

Over the last few years, the company’s management has pursued an active investment policy in the I&SS division, and it looks like the investment is starting to pay off.

Conventionally, Sony CMOS were used primarily in photo, video equipment and mobile phones, and the company never lost out to competitors in sales of sensors. Although SLR cameras have lost their former popularity among the average consumer, the overall sensor market is expected to grow at a steady 6.0% y/y as per IC Insights and Yole forecast. We believe the market has slightly higher potential. Strong sales will be fueled by the trend towards installing multiple cameras in cell phones, as this is one of the main industries using CMOS, as well as the development of autopilots and assisted driving systems.

The use of sensors is not limited to cameras and phones. According to the management, Sony is still not using full production capacity in its IS&S division, but revenue in the segment is up by 10% YoY. Demand for Sony products has followed a decline in demand for industrial equipment and security cameras. The process seems to be cyclical. With accelerating construction and recovery of the industrials sector, Sony will boost production capacity again, and future increases in self-driving vehicles will support growth of the division.

That said, the sector is generating normal operating margin even with lower volume. In a conservative scenario, we expect it to be 12.4% in fiscal 2022, with an increase to 13.9% in fiscal 2023.

Thus, we have a leader in a narrow and popular market with good prospects. Although the segment accounts for just over 10% of Sony’s total revenue, in our view it has tremendous investment potential and is positively reflected in the fair valuation of the entire group.

Valuation

According to our estimates, revenue of Sony will total ¥10 380 bn in fiscal 2022 (+4.6% y/y) and ¥11 758 bn in 2023 (+13.3% y/y), EBITDA will amount to ¥2 035 bn (-3.4% y/y) and ¥2 340 bn (+15.0% y/y), respectively.

As per current valuation, Sony is traded at 6.5x EV/EBITDA’22 and 5.7x EV/EBITDA’23, which is cheap, given the company’s strong market position. For our valuation, we took the industry median of 9.8x EV/EBITDA’23, discounted at 13%.

According to our estimates, the intrinsic value of Sony stock is $114, and we maintain Buy status. Upside – 71%.

Sony holds one of the leading positions on the market of game consoles, it has a wide range of exclusive content, and over the years has managed to attract loyal audience. The company’s business is well diversified. In addition to consoles and games, Sony manufactures consumer electronics, video cameras, makes movies and owns the largest recording studio. The company constantly invests in its development and grows both organically and by acquiring small promising companies.

Conclusion

We believe that Sony has high potential. It is a high-quality value stock with the leading position in many markets. Sony generates stable EBITDA and FCF, from which it also pays dividends and conducts share buybacks. The defensive characteristics and broad diversification of this business will keep it out of serious trouble, so with the shift in its economic agenda, Sony will be among the first companies to grow.

We maintain Buy status and believe that it is reasonable to take position in SONY stock now, but do it in parts, as there are signs of further declines in the major stock indices.

To manage the position, we recommend paying attention to financial statements and industry research (e.g., NPD, VGChartz, Counterpointresearch).