2023-06-18 04:16:59 ET
Summary
- Sonos, the home speaker maker, dropped ~20% after reporting fiscal Q2 results.
- The company cut its guidance, resulting in a low single-digit decline in revenue outlook due to slowing customer sell-through rates and reduced orders from channel partners.
- Stay on the sidelines until the stock drops below <10x FY23 adjusted EBITDA or fundamentals improve.
Though the general market sentiment has now shifted back toward optimism, many pockets of the market - especially in tech hardware - remain clamped down by macro challenges and tough fundamentals.
Such is the case for Sonos ( SONO ), the home speaker maker that saw a temporary boom in demand during the pandemic, as all things home goods-related enjoyed a spike from people moving and spending freely from rising asset values. The company recently reported fiscal Q2 (March quarter) results that caused the stock to drop a fresh ~20%:
I turned bearish on Sonos right before the downturn, which saved me quite a bit of painful downside this earnings cycle. Yet after digesting the company's latest results as well as its updated valuation, I still don't see any reason to stay invested here.
One of the key highlights from this earnings season: Sonos cut its guidance, and not by an insignificant amount:
Initially, the company's $1.7-$1.8 billion revenue outlook had implied single-digit growth on a constant-currency basis; now, the company's outlook points to a low single-digit decline. Sonos has noted a double whammy of both end-customer sell through run rates slowing down, as well as channel partners tightening inventory and reducing their orders.
Against this backdrop, even though Sonos' lower stock price is cheap, I don't think there's much of a path back to recovery here. At current share prices near $16, Sonos trades at a market cap of $2.08 billion. After we net off the $294.9 million of cash on Sonos' most recent balance sheet, the company's resulting enterprise value is $1.79 billion.
This puts these stocks at a valuation multiple of 11.7x EV/FY23 adjusted EBITDA, based on the midpoint of the company's $138-$168 million (8.5%-10.0% margin) guidance range.
Amid revenue compression, a weakening margin profile, and the very real possibility that the pandemic pulled forward a lot of demand for Sonos products that comes at the expense of this year and potentially next, I think there's very little reason to stay invested in Sonos through this slough.
I'd be interested in taking a look at this stock again if it dropped below <10x FY23 adjusted EBITDA (implying a $14 price target and ~13% downside from current levels), or if fundamentals began to creep upward again. Until then, I'm staying put on the sidelines.
Q2 download
Q2, which was Sonos' quarter ending on April 1, was one of the most dismal quarters in recent memory, both due to weaker trends this year and a tough compare against a strong quarter last year.
The Q2 earnings summary is shown below:
Revenue deteriorated -23% y/y to $304.2 million, though this came slightly ahead of Wall Street's expectations of $298.0 million (-25% y/y). Revenue did, however, decelerate sharply from 1% y/y growth in Q1. The primary driver behind this deceleration is a tough compare, as last year's Q2 saw a catch-up in channel inventories as Sonos exited supply constraints.
The company did introduce an interesting new enterprise service in the quarter called Sonos Pro, which gives businesses (think coffee shops and retail stores) the ability to control and change music playlists. The service starts at $35/month per location, and represents one of Sonos' first value-added software offerings that can hopefully shift the tide for its margin profile.
Still, this was unable to offset severe demand weakness in the quarter. Per CEO Patrick Spence's remarks on the Q2 earnings call:
But even as we made all of this progress, the near term macroeconomic pressures, we have flagged throughout fiscal 2023 intensified in Q2 and have diminished our second half and full year expectations. While our financial results have generally met the expectations that we outlined for the first half of the year, we observed softening underlying demand trends in the second quarter. This softening in conjunction with some of our channel partners tightening up on inventory has led us to reduce our outlook for the remainder of fiscal 2023.
Specifically, we're taking our fiscal 2023 revenue guidance down 6% at the midpoint, resulting in a constant currency year-over-year decline of 3%. We knew that this would be a challenging year, but this is disappointing and inconsistent with our ambitions.
I'd like to take a moment to further explain what changed since our fiscal Q1 earnings in February. First, exiting the holiday period, we began to see softening run rate registration trends in February, which continued through March. The market data that we track showed a pronounced decline in US home theater sales in March. While the European home theater market remains very challenged. Our home theater share gains in Q2 show that customers are still choosing Sonos over the competition despite the deep discounts that legacy audio competitors are offering. But ultimately, we are not immune to the widespread category weakness."
Note as well that new product registrations (a good proxy for end-customer sell through) declined -2% y/y.
Sonos' margin performance was also noticeably weak. Gross margins retracted -150bps y/y to 44.4%, as shown in the chart below; and came in 20bps below the company's guidance midpoint of 44.6%:
Note as well that Sonos' opex also grew 9% y/y to $154.0 million, representing 51% of revenue (versus 35% in the year-ago quarter), driven by much heavier spending in the R&D organization:
Opex growth should be muted in Q3 and onward, as Sonos recently announced layoffs covering 7% of its workforce . Still, however, I think this relatively small headcount reduction will be insufficient to mask the impacts of double-digit revenue declines.
Key takeaways
With contracting revenue, lower gross margins, dampening profitability, and no real catalyst back to growth other than the potential success of the new Sonos Pro program, I think maintaining caution on Sonos remains the best move. Keep this stock on your watch list, but don't rush in to buy the dip.
For further details see:
Sonos: No Near-Term Recovery In Sight