Sonos: Buy The Dip
Summary
- Shares of Sonos, the premium speaker maker, have fallen nearly 30% since a near-term August peak.
- The company is still experiencing substantial revenue growth north of 50% y/y.
- At the same time, gross margins and adjusted EBITDA margins are also rapidly scaling.
- A near-term 10% price increase may help to further expand the company's margins and better protect the company against supply-chain woes.
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Lukasz Kochanek/iStock Editorial via Getty Images
One of the best parts about broad market corrections, for investors who have a good chunk of their portfolios allocated to cash and bonds and can take advantage of dips, is the fact that the market tends to sell off rather indiscriminately - good, well-valued stocks fall alongside the highflier without fundamentals to support their rallies. Sonos (NASDAQ:SONO), the high-end maker of home speakers, is one of the most appealing recent dippers for value-conscious investors to invest into.
Sonos, over the past several years, has become a noteworthy household name. Like most technology product companies, the company built its brand around a flagship, high-end home speaker device. In recent years, however, Sonos has expanded into the mass market through partnerships with retailers like IKEA. This strategy, plus a continued expansion of Sonos' product portfolio, has allowed the company to catch a much wider net and achieve tremendous revenue growth.
Up until recently, the market was cherishing Sonos' growth story. At one point this year, Sonos shares had doubled since starting 2021 in the low $20s. Since then, however, Sonos has fallen nearly 30% from near-term August peaks above $40. This dip, in my view, gives investors a well-timed opportunity to buy into a high-quality stock during a temporary respite in price.
The bullish thesis and valuation for Sonos revisited
I'm especially confident on Sonos as the company's fall in share prices has been accompanied by a continuation of strong fundamentals. Sonos' fiscal third-quarter results, which we'll cover in the next section, showed nothing short of a company achieving against its ambition targets: growing revenue north of 50% y/y, and achieving strong gross margin expansion alongside double-digit adjusting EBITDA margin gains.
The only thing that may be weighing Sonos down is its acknowledgement of supply chain difficulties. Like virtually every other company across a number of industries, from Peloton (PTON) to Ford (F), Sonos is having a difficult time sourcing sufficient chips for its products. As a temporary respite to this difficult situation, Sonos instituted a 10% price hike across most of its portfolio in September. While price changes are certainly risky, we think the impact to Sonos' overall growth will not be net-negative, and will certainly help the company continue to drive gross margins upward.
Here's a refresher of what I view to be the key drivers of the bullish thesis for Sonos:
- Relatively low overall market penetration. Sonos' revenue guidance for 2021 implies that the company will only capture 9% of the $18 billion premium home audio market. Given Sonos' premium branding for high-quality sound and its continuous rollouts of new products, I think there is still room for Sonos to gain more and more market share.
- Thematic alignment to at-home entertainment. One of the biggest category winners in 2020 amid the pandemic was streaming. Netflix (NFLX) and Disney+ (DIS) intensified their competition amid a surge of streaming interest last year. And alongside the demand for streaming came heightened demand for peripherals like home speakers. As this trend continues, Sonos stands to benefit.
- Channel expansions. One of the most appealing aspects of Sonos is that it has a wide market reach through its aggressive channel marketing. Over the past year, one of the biggest drivers of growth for Sonos is the success of its co-branded IKEA products (the bookshelf speaker, SYMFONISK, starts at just $99), giving Sonos a lead in the entry-level market.
- Building margin profile. Sonos has achieved significant gross margin expansion through favorable product mix, declining tariff costs, and greater economies of scale. Its ~50% gross margins are enviable among hardware vendors. It's also relying more and more on full-price sales instead of discounts.
We note as well that Sonos recently raised its full-year guidance outlook. The company is now guiding to $1.695-$1.71 billion in revenue, and $270-$280 million in adjusted EBITDA: a significant bump versus $1.625-$1.675 billion in revenue and $225-$280 million in adjusted EBITDA previously:
Sonos Q3 earnings presentation
Right now, at current share prices near $31, Sonos has a market cap of $3.99 billion. After netting off the $670.9 million of cash off Sonos' most recent balance sheet, the company's resulting enterprise value is $3.32 billion. This gives the company a valuation of just 12.1x EV/FY22 adjusted EBITDA, which is an incredibly modest multiple for a company that is still growing revenue at an expected >30% y/y clip for the year.
We note as well that three years from now, for FY24, Sonos is expecting $2.25 billion in revenue at a 15-18% adjusted EBITDA margin. The midpoint of that margin profile implies $371.3 million in adjusted EBITDA, which would put the company's current valuation at just ~8.9x that longer-term EBITDA outlook.
The bottom line here: there's a lot of value to unlock in Sonos, and investors buying in now can take advantage of a very modest valuation that is backed by proven bottom-line profits.
Q3 download
Let's now cover Sonos' most recent fiscal third quarter results, which for Sonos is the quarter ending at the beginning of July, in greater detail. The Q3 earnings summary is shown below:
Sonos Q3 earnings presentation
Sonos' revenue in Q3 grew at a stunning 52% y/y pace to $378.7 million, beating Wall Street's expectations of $315.2 million (+26% y/y) by a massive 26-point margin. Note that this is the second quarter in a row that Sonos' actual revenue growth has come in at about ~2x what Wall Street had expected, which is a testament to how conservatively Sonos tends to guide and how muted expectations for this company are.
Management notes that supply-chain woes, longer lead-times, and extended customer quotes are now part of Sonos' everyday reality. However, CEO Patrick Spence notes that customers have been patient. Sonos expects to exit FY21 with a substantial amount of backlog (which will push revenue into FY22 and is a growth driver for next year).
Per CEO Spence's prepared remarks on the most recent Q3 earnings call (key points highlighted):
Our upwardly revised outlook calls for revenue growth of approximately 30% in the second half of fiscal 2021, adjusting for the extra week last year, up from our prior outlook of 20% growth. This is comparable to the 33% growth we delivered in the first half of the year despite the fact that supply chain constraints, which are broadly shared across our sector have increasingly impacted our efforts to fulfill the ever growing demand for our products.
Fortunately, our customers have shown both patients and loyalty, their willingness to wait for our products while we continue to work to build supply truly underscores the power of our system-based approach and our brand. Purchasing Sonos is a considered decision to enter our system, not just by a single product like so much of consumer electronics.
At this point, we expect to exit fiscal 2021 with a significant backlog, which we expect to work down in fiscal 2022. Given the exceptional momentum we are experiencing and the unwavering demand for our products. We are ahead of schedule toward achieving our fiscal 2024 targets outlined at our investor event back in March and are on track for what we believe will be a promising fiscal year 2022."
Several other business updates: Sonos has also enjoyed a successful launch of its new product Roam, a $179 portable smart speaker, and this launch packs onto an already-busy product roadmap this year, which rolled out new co-branded products with Sonos' existing Audi and IKEA partnerships.
Sonos also notched significant gross margin expansion in Q3, up to 47.0% and increasing 300bps y/y. The key drivers here were a greater mix of full price sales (versus a promotion last year), plus a net refund of tariffs; offset by higher raw material and logistics costs (a symptom that most consumer-products companies are also facing, and not at all unique to Sonos). Looking ahead, Sonos' 10% price hike in September should continue to produce gross margin leverage.
Sonos Q3 earnings presentation
Adjusted EBITDA also saw substantial lifts in the quarter. As seen in the chart below, Sonos achieved $46.7 million of adjusted EBITDA in the quarter, versus a -$2.7 million loss in the year-ago quarter. The company's 12% adjusted EBITDA margin this quarter represents a massive thirteen-point improvement against the prior year.
Sonos Q3 earnings presentation
Year to date, Sonos' adjusted EBITDA of $261.5 million is also up more than 4x versus the prior year. We note that even now, Sonos' FY21 guidance, which calls for just $270-$280 million in adjusted EBITDA, is highly likely to be broken, as we don't think it realistic that Sonos would generate just ~$10-$20 million of adjust EBITDA in the fourth quarter (versus $46.5 million in Q4 of last year).
Key takeaways
Sonos fell in kind with the rest of the market over the past month, but investors would be wise to take this dip as a buying opportunity in a very strong consumer-products company that has a history of balancing growth, continuous product innovation, and profit expansion. Stay long here.
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SONO either through stock ownership, options, or other derivatives. 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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