Company Reports

Wide-moat Sony’s operating income for the June quarter was JPY 279 billion, up 10.3% from the previous year. This was slightly below our forecast of JPY 295 billion. Still, the shortfall was mainly due to the pictures segment, which is difficult to forecast on a quarterly basis due to its volatility, and other segments were mostly in line with our expectations. The company protected its profitability by tightly managing its inventory and benefiting from the growth in high-end products while demand for smartphones and TVs remained sluggish. We believe this resilience of Sony’s electronics business is a testament to the company’s strong management.

As technologies and consumer preferences change rapidly, it is generally difficult for consumer electronics companies to build an economic moat. The replacement cycle for digital appliances is usually four to six years, but as most products are commoditized, it is difficult for manufacturers to build an ecosystem that prevents customers from switching to other brands. As a result, Sony’s profitability on electronics had been unstable in the past, while its music, movies, and financial services businesses have generated solid results.

We upgrade Sony Group’s moat rating to Wide from None, based on the intangible assets and switching costs. Over the past decade, Sony has shifted to an asset-light business model, focusing on content acquisition, and developing recurring revenue businesses that enable long-term monetization from customers. As a result, while Sony’s return on invested capital track record is poor, we believe the company’s current business portfolio is much stronger than before and can generate ROIC above the weighted average cost of capital over the long term. Due to the moat rating upgrade, we raise our fair value estimate for Sony to JPY 18,000 per share from JPY 16,000 and to USD 112 per US ADR from USD 103. We believe its shares are currently undervalued.

As technologies and consumer preferences change rapidly, it is generally difficult for consumer electronics companies to build an economic moat. The replacement cycle for digital appliances is usually four to six years, but as most products are commoditized, it is difficult for manufacturers to build an ecosystem that prevents customers from switching to other brands. As a result, Sony’s profitability on electronics had been unstable in the past, while its music, movies, and financial services businesses have generated solid results.

Sony Group guides operating income of JPY 1.28 trillion for fiscal 2024 (ending March 2025), up 5.5% year on year, or 9% growth excluding the financial segment, which is sensitive to market fluctuations. While the guidance is largely in line with our expectations, we believe that 1) solid growth in the game and network services segment, which had been a concern due to the lack of major first-party title launches scheduled for this year; and 2) improving profitability in the imaging and sensing solutions segment, which had been suffering from deteriorating yields and rising fixed costs, will alleviate the market’s concerns.

As technologies and consumer preferences change rapidly, it is generally difficult for consumer electronics companies to build an economic moat. The replacement cycle for digital appliances is usually four to six years, but as most products are commoditized, it is difficult for manufacturers to build an ecosystem that prevents customers from switching to other brands. As a result, Sony’s profitability on electronics had been unstable in the past, while its music, movies, and financial services businesses have generated solid results.

As technologies and consumer preferences change rapidly, it is generally difficult for consumer electronics companies to build an economic moat. The replacement cycle for digital appliances is usually four to six years, but as most products are commoditized, it is difficult for manufacturers to build an ecosystem that prevents customers from switching to other brands. As a result, Sony’s profitability on electronics had been unstable in the past, while its music, movies, and financial services businesses have generated solid results.

Sony Group’s December quarter operating income of JPY 463 billion exceeded our expectation of JPY 430 billion, mainly due to the improvement in net gains from market fluctuations in the financial services segment, which are difficult to predict. Aside from this one-time factor, we believe Sony’s operating profit was largely in line with our expectations, with the lower-than-expected profitability in the game & network services segment largely offset by margin recovery in the imaging & sensing solutions segment.

We maintain our fair value estimate for Sony Group at JPY 14,500 per share, but our fair value per U.S. ADR is trimmed to USD 97 due to currency movements. While the PlayStation and the image sensor businesses did not meet our expectations, the shortfall is largely offset by the weaker-than-expected Japanese yen and robust sales growth in streaming music. Therefore, we largely maintain our earnings forecasts and our view that growth in the content businesses (games, streaming music, and movies) and the image sensor business will drive Sony’s growth in the medium term. Meanwhile, we are somewhat concerned that the long-term strategy of the game business is becoming uncertain as the restructuring of its game studios is underway and the pipeline of first-party games is being revised. Jim Ryan, president and CEO of SIE (Sony’s gaming division), who has been with Sony for about 30 years, has announced his retirement and a successor will be selected under the leadership of Hiroki Totoki, president of the Sony Group, who will serve as interim CEO of SIE. The long-term strategy for the game business will be formulated under the new CEO.

As technologies and consumer preferences change quickly, it is generally difficult for consumer electronic companies to build up an economic moat. The replacement cycle of digital appliances is usually three to six years, but as most products are commoditized, it is hard for manufacturers to build an ecosystem that prevents customers from moving to different manufacturers.

Despite somewhat disappointing June quarter results, we maintain our fair value estimate for Sony at JPY 14,500, while our fair value per U.S. GDR is lowered from USD 110 to USD 100 due to the weaker Japanese yen. The growth of PlayStation 5, or PS5, and image sensors is not as fast as we had expected, but we believe they will return to a growth trajectory in the next fiscal year. Meanwhile, our outlook for sales in the music segment to continue to grow along with the expansion of the streaming music market remains unchanged, and other businesses—consumer electronics and pictures—will maintain solid profitability with disciplined cost control. As a result, we are changing our Uncertainty Rating to Medium from High due to the improved stability and visibility of Sony’s earnings. While we lower our fiscal 2023 (financial year ending March 2024) earnings forecasts, we largely maintain our outlook for 2024 and beyond, and we view Sony’s shares as undervalued as the market is too pessimistic about the temporary slowdown.

As technologies and consumer preferences change quickly, it is generally difficult for consumer electronic companies to build up an economic moat. The replacement cycle of digital appliances is usually three to six years, but as most products are commoditized, it is hard for manufacturers to build an ecosystem that prevents customers from moving to different manufacturers.

Although Sony’s full-year operating income guidance for fiscal 2023 (new fiscal year ending March 2024) of JPY 1.17 trillion is about 10% lower than our forecasts and the PitchBook consensus of around JPY 1.3 trillion, we believe the guidance is conservative and reflects the cautious view of management amid economic uncertainties. In particular, we see some upside in two business segments, game and network services, or G&NS, and imaging and sensing solutions, or I&SS.

Based on weaker demand and the change in currency assumptions, we have updated our earnings forecasts for three consumer electronics companies, revising Panasonic Holdings' fair value estimate to JPY 1,400 from JPY 1,450, and Casio Computer’s fair value estimate to JPY 1,650 from JPY 1,800. Sony Group’s fair value estimate per U.S. ADR is revised to $110 from $100 due to the stronger Japanese yen, while its fair value estimate per share is maintained at JPY 14,500. As indicated by the change in our fair value estimates, we believe that Casio is the most vulnerable to changes in the business environment, leading to the largest downward revision in its earnings forecast. On the other hand, Sony has been able to minimize the impact of the economic slowdown thanks to structural reforms implemented by current management. We believe that Sony is the most attractive of the three consumer electronics companies from a risk/reward perspective, although we believe that all three stocks are undervalued and have 20%-30% upside to their respective fair value estimates.

As technologies and consumer preferences change quickly, it is generally difficult for consumer electronic companies to build up an economic moat. The replacement cycle of digital appliances is usually three to six years, but as most products are commoditized, it is hard for manufacturers to build an ecosystem that prevents customers from moving to different manufacturers.

While many other companies were forced to cut their full-year guidance due to the economic slowdown and rising costs, Sony Group was able to raise its fiscal 2022 (ending March 2023) operating income guidance from JPY 1.16 trillion to JPY 1.18 trillion. Sony’s results for the December quarter were impressive mainly in two ways. First, Sony was able to successfully cope with a challenging business environment. In particular, the electronics and image sensor businesses were able to minimize the impact of the economic downturn by improving their product mix, which we believe is a testament to Sony’s disciplined operations. Second, the games business, where user engagement had been declining for the past two years, showed signs of bottoming out. Overall, we believe that the solid results once again demonstrated the resilience of Sony’s business portfolio. We plan to revise our earnings forecasts and fair value estimate after meeting with the company later in February, but we maintain our fair value estimate of JPY 14,500 and our view that Sony’s shares are undervalued.

Although its game business continued to struggle, Sony delivered an impressive result for the September quarter. We believe that Sony was able to minimize losses from ongoing headwinds through its excellent management and operational capabilities, and as a result, was able to fully benefit from the solid demand for image sensors, digital cameras, and streaming music. We will revise our earnings forecasts as well as our fair value estimate after meeting with the company later this month, but we do not expect to make any material changes to our numbers. We still see Sony’s shares as undervalued, and believe the bottoming out of the PlayStation Network’s active user base will be the catalyst for the stock price.

As technologies and consumer preferences change quickly, it is generally difficult for consumer electronic companies to build up an economic moat. The replacement cycle of digital appliances is usually three to six years, but as most products are commoditized, it is hard for manufacturers to build an ecosystem that prevents customers from moving to different manufacturers.

In light of the slowdown in the gaming industry, we lowered our fiscal 2022 software shipment assumptions for Nintendo and Sony. We believe that consumers' spending is becoming less active due to the uncertain economic outlook and that spending is becoming more skewed toward outdoor activities as the coronavirus begins to abate. As a result, we forecast that game shipments in our five-year forecasts for both platforms will not exceed the peak they had recorded during the pandemic. Nevertheless, we view both shares as undervalued and believe Sony has a larger upside to our fair value estimate as the market is underestimating solid growth of digital content and improving product mix of image sensors.

Amid various uncertainties, we are encouraged by Sony Group’s solid guidance for fiscal 2022 (financial year ending March 2023). In particular, revenue growth guidance for two business segments, the game and network services segment and imaging and sensing solutions segment, was much higher than we had expected. Based on the positive revenue outlook, we believe that Sony’s new operating income guidance of JPY 1.16 trillion, 1.9% up from the previous year excluding one-time factors, is conservative, which is not surprising in a time of great uncertainty. We plan to review our earnings forecasts after Sony’s business segment briefings, which will be held later this month. Nevertheless, we believe Sony’s shares are undervalued as we believe Sony’s business portfolio is much more resilient than the market seems to believe.