2023-08-16 16:32:14 ET
Summary
- Sony's share price has been underperforming, but the PlayStation segment is expected to provide strong numbers in the future.
- The upcoming release of the PS5 Slim and new accessories will contribute to continuous revenue growth.
- The company's financial health is decent, with manageable debt.
Investment Thesis
Sony’s ( SONY ) share price has not been performing too well YTD, so I wanted to see if the company is a good buy at these prices. The company has decent financial health in my opinion, and I believe that the PlayStation segment for the company will continue to provide great numbers in the future, which will be boosted by the many peripherals/accessories that are to be released shortly. I believe the company is a buy at these prices for the long-term investor.
Outlook
The company has many revenue segments; however, I will primarily focus on the biggest revenue generator, which is Game and Network Services. Biggest in terms of revenues generated, not operating income as the Music segment performed better in that regard. The PlayStation 5 console has been a major success even during the shortage times. The console shortage turned out to be an involuntary marketing campaign, where it seemed like everyone was trying to get the console but only a select few managed. I managed to snag one sometime in December 2020 for retail price, unlike some poor souls who got robbed by scalpers, and I’ve been enjoying it ever since. The console has been out for almost 3 years now and has been performing better than the PS4 did in the same time frame as seen here. So, it looks like even with the shortage problems, it is going to perform better than the last generation console.
It seems like the shortages are over now because the y-o-y sales in July were up 68% . There are also discounts running on the consoles in most major retailers, which suggests whoever wants to get a console can easily walk into their local store and get one and that is being reflected in that July report.
The Slim Version
As I mentioned, it is almost 3 years now since the original PS5 came out, which means a “slim” version is on the horizon. The PS4 came out in November 2013, and the PS4 Slim came out in September 2016, meaning if history repeats itself, the PS5 Slim should be coming out just next month. With a recent “leak” of the slim case of the console doing the rounds on the internet, it seems like it may well be true that we will see a slim-down version of the console, which is not a major update to the console-like the pro version, so I wouldn’t be surprised if it does come out next month. This will provide the company with a continuous stream of revenue until the next big thing.
I should mention that the Pro version is supposed to follow in November as the PS4 Pro followed the slim release, however, I don’t think that will be the case here for the current generation console because even though the PS5 outpaced the PS4 in the same time frame, it still feels like the PS5 is too new to have an upgraded version yet, but we will have to wait and see what is Sony going to announce in the future events.
Accessories to the Console
I was a fan of PSVR, and I am going to get the PSVR2, however, I do feel it is a little too expensive right now. And it looks like I'm not the only one because the sales figures have been disappointing and the company is cutting production by 20% this year. The accessory costs more than the console itself, so I wouldn't be surprised that a price cut will come sooner rather than later to avoid a disaster, which will mean lower margins overall. The VR space is getting more traction with the Meta's ( META ) efforts to make it mainstream and with Apple's ( AAPL ) ridiculously priced headset, however, it looks like this segment has still a long way to go before it becomes accepted by the mainstream population.
The new Dual Sense Edge controller has been a great addition to the console, which has been performing much better than I had expected. I was thinking the tag price of $200 is a bit much, however, the gamepad became a best-selling gaming accessory in June '23.
The upcoming handheld streaming device may sell decent enough also. It may be a very niche market, but I believe it is going to be filled. I've been on the road for a bit now and I wish I had that device to be able to go online remotely for sure, couple the handheld with upcoming PS5 earbuds and you have a full gaming setup on the go if you have a decent internet speed of course. I would have preferred a proper handheld console like the Vita or the PSP, but it may seem like Sony is done with that and will focus its time on 4K streaming.
In summary, it looks like the company has a lot of revenue potential in Game & Network Services. Some are more promising than others like the new version of consoles and gamepads. Other accessories like the VR headset and the handheld will be good enough to cushion revenues further as I don’t think these will become major sellers for years to come. I do think these will sell decently throughout the current generation.
Risks
The strike in Hollywood is a big risk going on right now and we don’t know what kind of impact it will have on the company’s movie division. I do know it won’t be a positive one. The Last of Us season 2 has been put on hold because of the strikes. The first season was a huge hit and the longer these strikes continue the more the company will lose revenue.
Sony might make a muck out of the next console release like it did in the PS3 era and people decide not to upgrade and switch to a competitor instead. This one is I think not that much of a risk because of that debacle with the PS3 but it could happen if shortages start to creep up again and margins get squeezed, which will make Sony pass the burden onto the consumer.
There is still very little known about AI and the future of music production, however, that may be something to keep an eye out on.
Financials
Just to note, I will be looking at the numbers in dollar terms that I gathered from a third-party financial website, which may have used a different FX rate, so the numbers may not match but will be in the ballpark. I will also look at full-year results as these will give me a better understanding of where the company is heading in the long run rather than q-o-q results, which may fluctuate too much.
As of FY23, Sony had around $11B and $3B in short-term investments, against ~$13B in long-term debt. The annual interest expense on debt at the end of FY23 stood at around $92m, while EBIT was around $8.8B, so I think the debt is not an issue here because that means that the interest coverage ratio is around 95x. For reference, a healthy interest coverage ratio is 2x, so I don’t think the company has any risk of insolvency anytime soon.
The company’s working capital ratio, or the current ratio, is not the greatest and is under my minimum of 1.5. I would like it to be at least 1.0 but the company has been operating below 1 for quite a long time now, so I’m assuming it is not the biggest issue. A current ratio of over 1 is only needed if for some reason the company has to pay off all its short-term obligations at once and that is not going to happen to Sony.
In terms of efficiency and profitability, ROA and ROE are also on the lower end of what I like a company to have, and ROA is also a little under my 5% minimum, while ROE is 3% over my minimum, so it is quite a mixed bag there. The company has seen better returns in the past and it would be great if these improved in the future, but only time will tell. It seems like the management isn’t utilizing assets very efficiently while using shareholder capital decently in my opinion.
The company’s return on invested capital has also been at a low end for a few years and is below my 10% minimum. It seems that the company may not have that much of a competitive advantage, or there isn’t much competitive advantage in the industry because of competition from other players like Xbox ( MSFT ) or Nintendo ( NTDOY ), and if we compare Sony to them, we can see that the others are performing better, granted MSFT is a much bigger company where the gaming division isn’t the main revenue generator.
Return on Total Capital (Seeking Alpha)
Overall, nothing to brag about on the financial side of things. I have seen some better numbers in other companies; however, it looks to me like Sony would be able to survive any sort of downturn if it ever happens.
Valuation
The revenue numbers look much better if we would look at them in Japanese Yen terms, however, most investors are investing in dollar terms so I will stick with this too. I decided to grow USD revenues by around 2% CAGR for the next decade on the base case scenario, which is about the average growth in USD the company experienced in the last decade. For the optimistic case, I went with around 6% CAGR, while for the conservative case, I went with 0% growth.
In terms of margins, I decided to improve gross and operating margins by around 200bps over the next decade, which I think is very doable. This will bring the net margin from around 8% in FY23 to around 11% by FY33.
On top of these estimates, I will add a 25% margin of safety to give myself even more breathing room. With that said, Sony's intrinsic value is around $103.60, implying around a 23% discount from the fair price right now.
Closing Comments
So, even with somewhat conservative estimates for the next decade, the company seems to be a good deal right now. Sony is trading at around 15x, which isn’t the cheapest it’s been. It’s at around the midpoint, which I think is not a bad time to start a position and add on weaknesses in the long run. Ideally, the company drops further to around 11x-12x, which in my opinion would be a huge opportunity to start a proper position, unless the long thesis is not intact any longer.
The company makes a lot of great products, so I don’t think it is going anywhere anytime soon and will continue to provide us with entertainment for years to come.
For further details see:
Sony Corporation: A Good Time To Start A Position