Sony Blockbuster Profits And Guidance

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About: Sony Corporation (SNE)
by: Nick Cox
Summary

Gaming & Semiconductors lead the charge.

Divisions showing better growth and profitability across the board.

Secular trends make Sony a long-term growth story.

Sony (NYSE:SNE) is forging ahead division by division with Gaming and Semiconductors leading the charge. Its Q2 results showed a 346% growth in operating profits and forward guidance exceeded what even the most bullish analysts had expected. In the quarters ahead even this improved guidance may well get exceeded. Sony remains a good buy despite the higher stock price.

Sony's Divisions.

Many analysts had thought Sony had reached peak sales on its gaming business led by the PS4. However they had under-estimated the switch from consoles to digital sales, to subscriptions and to in-game purchases. The 'Fate/Grand Order" game has boomed for the company, and new games are coming soon. As for semiconductors, the company's position in its Image Sensor division continues to strengthen.

The growth across the board for Sony is shown below as per the Earnings Call slides:

The remarkable transformation of the company by CEO Kazuo Hirai is showing clear benefits. I detailed this in a previous article. Investors such as Daniel Loeb had previously called for breaking up the company. They were very wrong. The transformation shows up in both in the improvement in total operating income and on a division by division basis. Operating income for gaming up 35.85,for semiconductors up 53.6% and for Music up 16% illustrate how the jewels in the crown are doing for Sony. Music is getting increasingly important for the company. Much of the rise in that has been boosted by the increase in streaming services, especially in their home market of Japan. This looks set to continue as a secular trend. Even the television business boomed, a sector many thought the company would quit after years of non-profitability.

The only division not in the positive was Mobile Communications. Sony continue to have difficulty expanding their excellent but under-performing "Xperia" range of phones. They however remain part of the company's Internet of Things and mobile game-plan. Those who say Sony should sell off this division fail to understand the vision of the company.

The company is also busy trying to invent the "next big thing" at its "Internal Accelerator Programme". CEO Hirai recently appeared on stage with a robotic dog known as "Aibo". This will at first be sold just in Japan at a price somewhere around US$1700. It shows though the company's drive in AI.

The company could become a leading player in areas such as robots, self-driving cars and drones. Much of this would be based on their Image Sensor division and progress on time-of-flight sensors. They also have interesting initiatives in the Medical sector.

Earnings Call.

Kenichiro Yoshida, executive deputy president and CFO, had some interesting areas to emphasize at the earnings call.

In regards to gaming, he emphasized how the focus is shifting to selling consoles to the user base and to in-game sales and online purchases. The company's huge lead over the Microsoft Xbox should enable the company to continue to dominate this sector.

Yoshida was particularly optimistic on the Semiconductor division. He confirmed the increased forecast for the year was based mainly on the booming sales of the company's image sensors for mobile phones. The company is increasing their production capacity. It only recently returned to full production following earthquake damage. He saw long-term growth in fields such as automobiles, drones and dual lens cameras.

Home entertainment and sound, whose results have surpassed many observers, was doing well on the back of 4K televisions and larger screens of over 55". Their forecasts for both sales and operating income was partly predicated on the back of the falling price of television panels.

He confirmed Music was boosted by the move towards streaming and the success of their mobile game app "Fate/Grand Order".

The Pictures division has been much criticized by observers. Yoshida was optimistic about expanding the Spider Man franchise following the success of the movie "Spider Man:Homecoming".

On new product areas he remained optimistic on the company's burgeoning Medical business, but stated that it was now unlikely to meet their original target of 200 billion Yen (US$1.75 billion) in sales by 2021.

On dividends, Yoshida said they would be increased in the future if conditions allow. One gets the feeling though that this is not a priority for the company. They prefer to invest in new product areas and ramp up image sensor production. Dividend yield is at just 0.41%

Stock Price.

In early October I had recommended readers to buy Sony before the Q2 results announcement.The stock price had declined due to wrong-headed recommendations from analysts who thought the Gaming sector growth was played out. I detailed that here.

A look at the stock price chart below shows this was good advice:

Analysts have been continuously wrong on the Sony stock price. The average consensus now is that the price could reach US$50 but to me this is still conservative. (the price is US$44.81 at the time of writing). The historically very conservative guidance of the company should be taken into account.

Valuations are still reasonable despite the surge in the stock price recently. According to figures from Charles Schwab (subscription required), Sony compared to the S & P Global Consumer Discretionary is as follows:

Price/Forecasted Earnings : 16.5x (versus 17.82 for the S&P500).

Price/Sales : 0.78x (versus 1.12x for the S&P500).

Price/Cash Flow : 14.05x (versus 11.39x for the S&P 500).

The PEG ratio is at just 0.34. All other things being equal, it is usually considered a company has good upside potential if it has a PEG ratio of under 1.

Sony upped its full year forecasts at the results, as detailed below:

A 26% increase in forecast operating income between August and October is quite unusual. Bearing in mind conservative forecasts by the company, and the fact that Sony can be considered a growth company today, this gives more room for upward movement.

Conclusion.

The company is forecasting a full year operating profit of 630 billion Yen (US$5.5 billion). This would be over 20% more than their best-ever performance, dating back to the glory days of the Walkman. In 1998 their stock price was substantially higher than it is today when they made their previous record profit of US$526 billion yen (US$4.6 billion). Valuations today are much better than they were then.

To me, Sony is under-rated and not covered much for the size of the company. This may be because they are in fields usually dominated by U.S. companies. The company is benefiting from product concentration being in the right place at the right time. Its focus on gaming, the mobile world and music is exactly where a company needs to be to catch the Youth market. The secular trends are in Sony's favour.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.