Chit Chat Stocks - Fundamental Analysis: Sony (SNE)

Episode Date: October 4, 2020

Your hosts, Brett Schafer and Ryan Henderson, take a look at the Japanese conglomerate Sony. Sony owns and operates over 30 different companies under its large umbrella. Pay close attention as Ryan covers the history of Sony and Brett takes you through Sony's current valuation.  Watch this episode on YouTube: https://youtu.be/Ye5r0o2WfHw Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney  Visit our website to see more from your hosts Ryan and Brett. https://www.chitchatmoney.com/  If you are looking for us on your podcast listening platform, look no further.  Apple: https://podcasts.apple.com/us/podcast...  Spotify: https://open.spotify.com/show/4SBtOWG... --- Support this podcast: https://anchor.fm/chit-chat-money/support Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

welcome in this is the fundamental analysis show where we cover a stock in 20 minutes giving you a nice sunday episode ryan is here with me today and we are talking sony the japanese conglomerate we kind of got a japanese tilt here the last you know start here because buffett buffett got all those right right what was it japanese companies japanese debt something like that whales whale wisdom yeah we're looking at uh more conglomerates he was in like trading companies like ancient trading companies classic clickbait buffett story but that's not what the show is about we're talking sony the conglomerate so when you get into the history and then what sony does sony is one of the world's largest manufacturers of consumer and professional electronics um so

even though they've produced the most successful console ever which was the ps2 and they are the second largest video game publisher worldwide sony's actually not as cyclical as you might imagine they've broken out their revenue into seven different segments so they have games and network services music pictures electronic products and solutions imaging and sensing solutions financial services and all other and then i'm gonna sorry i'm gonna imaging and sensing they say like that but it's mostly semiconductors so at the start you're like oh imaging and sensing what does that think like semiconductor and adjacent stuff okay and they yeah they do a lot they're giant global conglomerate um electronic products and game and network services are their

largest divisions so um think i mean i guess tvs consoles cameras game and network um basically the software component to the gaming and all that music music ip they own spider-man ip is their that would probably be in music though right yeah but they also own the marvel so marvel actually doesn't own the spider-man part spider-man is owned by sony so that's kind of like for some reason they own that specific one and then actually uh they own though they have 31 different companies i counted them up in the 10k uh 31 different so it really is a classic conglomerate with just total like random industries that they work in interesting okay um history sony was founded in tokyo japan in 1946 though it wasn't actually named sony until 1958 they were started

as an electronic store by masaru ibuka and their early uh their big early product was the sony transistor radio since then they built out tons and tons of different businesses that go under the sony umbrella now um the sony first went public or was made available to the public in 1955 and they listed on the new york stock exchange for the first time in 1970 interesting note though sony financial ipo'd in 2007 um and now they're rolling it back in so yeah this spring um they're going to take that all in-house it's kind of a they're going to buy out all the outside owners and just make it 100 owned company and then the only two major shareholders i could find were of course blackrock every time blackrock japan and some japanese asset management company

both owned roughly 5 all right yeah i'll get into the valuation because we could talk about the history for days it could be a whole episode so they have a 78.9 billion dollar enterprise value and that is estimated as of the recording date on october 1st their ticker is sne and they're i don't know if they're an adr i don't believe they are i think they actually because they do list on the new york stock exchange it's not one of those weird international things where you're actually not investing in the company i think they were or they are an adr i saw something on like the sony page that said they issued their adr a long time ago either way it's a japanese company you can well i mean i don't want to stereotype as them as being trustworthy but i think you can

trust them over like a riskier chinese company which is where you worry about those adrs a little more uh the price though is 76 and 44 cents as a recording um they have a weird with their financial services thing that makes the enterprise value weird. And they also have negative $15 billion in net debt for calculating their metrics. So you got to put that in there just to actually get the real, you know, valuation. They have an EV to free cash flow of 8.6, PE of 15.3, and then EV to EBIT, which is earnings before taxes of 10.5. I like to do all three of those because, you know, sometimes they can massage earnings to make one look better than the other. you kind of want to see all three look good because it just gives you a better overview

where you can maybe do an accounting trick and make someone think that your valuation is a lot lower or sometimes it's not even an accounting trick sometimes it's just like one-time blips that only affect one of those profitability metrics right and so all three of those i think are the best to like look in tandem just because you know a pe might look really low or really high but in reality the cash flow is a lot better dividend yield right now is about 0.6 so not strong, but it has been growing. They said they do want to grow it and their buybacks have been small. Share count has been very steady. Trailing return on invested capital of 15.4%, which is good. EV to operating cash flow of 5.8. Free cash flow margin 12%. They have negative working

capital, but they have done that for the past decade and it hasn't been an issue for them. I think it's because they've been able to generate solid cash flow. And it's not too concerning when looking at their balance sheet, they do have long-term debt, but it is out on a bunch of different years. It doesn't all go at one time and it's not very large for the size of the company. Balance sheet is relatively complex. Again, it's a conglomerate, so you might expect that. And it's kind of something you're going to, you know, we're not going to go over every point on this on the show, but if you're going to invest, you're going to have to spend some time going over that to make sure you understand every part of the business. All right. I'll dive into the earnings then.

These are all basically trailing 12-month numbers. And then when I do the year-over-year metrics, it's the trailing 12 months from the year prior. So over the trailing 12 months, Sony has produced roughly $77 billion in revenue. That's down roughly 4% year-over-year. They had operating income of $7.9 billion. That's down about 2.5%. And then trailing 12-month net income was $6.1 billion. That was actually down 21% year-over-year.

It's lumpy. um and you're gonna we're gonna find that and talk about that more but there's a lot of lumpiness to the business and then especially in the the covet year right and uh there was 9.2 billion in short term borrowings and 6.2 billion in long-term debt like you just talked about their balance sheet was difficult to dissect and it's not what you as an investor might be used to because it's chinese Japanese sorry Japanese documents and it's like the 20f instead of the 10k and the financial part makes it so they're holding a bunch of marketable securities for the life insurance business it makes things seem maybe a little worse or different than they are right they had 10%

operating margins over these trailing 12 months they had 8% net margins both are partially down from the year prior thought this was interesting though in 2012 they had 168,000 employees last year they had 111 000 employees a 34 percent decline in headcount i'm curious how much that is helping lead to uh i mean since 2012 operating income has expanded yeah i'm curious margin's been a lot better right yeah i mean it's still lumpy somewhat and you could pick random years and it might be off but it they are more profitable on a margin basis it just i'm curious if that plays into it. Maybe some automation. Who knows? you

all right welcome back from the ad break first up here this is one we do for the fundamental analysis show it is digging trenches and that's just yes or no what do you think they got any moat competitive advantages it's one out of three right one oh yeah yeah it's one out of three i forgot uh or you could say zero yeah yeah um it's uh three i guess two i mean there's so many different businesses within the business i'd say probably two and a half we you know yeah i mean the console area there's basically three players the switch the playstation the xbox um right now and it should i mean unless cloud gaming really takes off and stadia happens to be better than it is now i don't see it feels like they have a moat there there's a lot of definitely tons of

brand recognition with sony you kind of know what you're getting music licensing is really i mean it's a moat because people are forced to pay you know the royalties like this is who spotify has to pay all that money out to is sony and it's very high margin but there's also some of their business is sort of commodity products like tvs some of the electronics headphones stuff like that i mean the more the competition comes in the more they have to lower prices or compete on price yeah so part of the business has a very high moat and part of it does not at all all right um so i guess yeah two two and a half two and a half somewhere in there um what about further reading further reading i wanted to look more into the images and sensing so i kind of got the gist of

it they're like the number one brand for the specific niche of semiconductor and other products is kind of like computer vision which could be a big growth opportunity but i it's hard to understand you got to get down to the technical weeds there um and it's you know a business that isn't really intuitive unless you're big into the semiconductor and engineering industry um you know what part of the market are they focused on i would kind of look into i think they have automotive and then in general this is a highly complex company so there's a lot of things we're not going to cover on the show here there's just tons of further reading for example they just invested in billy billy in china and they now own five percent of that that's worth almost one billion

dollars i think maybe like 800 million what's billy billy again i i don't know see yeah you gotta look and just see what they even do okay um yeah so mine's the financial services segment They own SFH, which I didn't look up what it stands for, but it basically is their financial – Sony Financial Holdings. Right. And then that engages in insurance, savings, and loans. Everyone knows banks ultimately use more leverage, and so it adds an element of risk to Sony as a whole. All of Sony's short – of all of Sony's short-term borrowings, 90% belong to their financial services segment.

So there's just a whole other part that you have to analyze because it adds – basically, I would say that's 90%, maybe 80% of Sony's risk or executional risk as a business in general. And it's all in their financial services segment. So you got to figure out what's going on there. Yeah, definitely. And they're probably upset. They've been doing this for a while. And they're like, gosh, we're just in the worst interest rate environment, like in history for Japan, specifically with those negative rates, basically zero rates for the last three decades. All right, future growth opportunities. What do you got? Mine's the PS5. The PS5 is launching on november 12th last time the last time they launched a major console was at the

end of 2013 and the year following they saw a 14 14.3 increase in the top line um and that was the ps4 so that was the fourth best-selling console ever so think about that you had the fourth best-selling console ever and it and it helped revenue jump only 14 it's because they um i believe i believe they have really strong pricing power with that right that had historically been able to raise prices is that true were you looking i believe that's true right it doesn't it's crazy that something so big doesn't move the needle that far you know that's true um but so more to the ps5 the the pricing was pretty smart from what it looked like so they have the disc the one with the disc running capabilities will be 499 and the disc free version is selling for 399

so they're probably making mild margins on the initial hardware sell for the 399 version but the games will be software downloads which are higher margin and i imagine people are going to spend more than that hundred dollar gap to buy games so they're basically making up the margins later on in the life of the console and they have the playstation now which has like what 45 million users um so that's that's high margin as well okay and then um yeah it's just that that's the cheaper way when you put a 499 version and then a 399 version it's a cheap way to get into the households and then you can make higher margins later on although xbox is doing the same but their digital only version is $299 that's a little interesting i'm curious if maybe

xbox or microsoft is taking a bigger jump on the services side i mean historically playstations had more pricing power um just from the console launches in the past uh just people seem to be willing to pay more for playstations uh for whatever reason which i guess is a good thing what's your future growth opportunity uh it would be the large investments they're making in the images and sensing business line for automotive so this is a huge expense for uh research and development for self-driving cars companies are spending billions and billions on that uh you know all different companies from tesla to the classic old companies in the automotive space everyone is investing in that because they know eventually it will occur we don't really know when but i think

this could be a large part of that market that actually has profits flowing to it because you know there needs to be that imaging uh technology and semiconductors are going to be play a big part of that and then there's also all the computing that goes with it so it's going to take a lot of investment from sony but it could pay off and it could be one of the few companies that actually has the technical specs to pull it off so that you know with all their employees with you know you can't just have a startup to uh compete in that space and it's also a little complicated it might be a little over our heads and not in our specific niche that we like to invest in but it's kind of a good, you know, maybe a call option on this business

because it isn't a giant part of their business right now as, you know, Sony, the conglomerate, but it could eventually be if, you know, if things work out. That's the thing that I find so interesting is even if that's super, super successful, it doesn't totally transform the business. No, but it's also on the flip side. It's not going to kill them if they don't succeed. Right.

What about your highlights and lowlights? okay my highlight for me was as a conglomerate their income is more stabilized when the macro economics change so for example last quarter gaming got a big revenue and income bump but that was you know able to offset the losses and electronics um and actually gaming is i think usually the highest segment uh per revenue you know on revenue basis and last quarter was actually the majority of the revenue so usually it's like 30 something percent but it has gotten up to at least 50 i also like how they're going to be absorbing their financial subsidiary as a wholly owned business just get that in house why not um keep everything streamlined low lights for me a

lot of the products are hardware um not all of it is but you know hardware is harder too i mean margins are worse it's a one-time buy stuff like that it's more hit driven also their ip stuff um i mean maybe are they just milking the streaming and music bump you know like you know streaming video streaming music that stuff's getting a big bump right now and sony doesn't really feel like it's doing much on that um it still might work but i don't know how much they're actually investing in that ip also if you believe that artists are going to move away from the labels that's a future that's a risk for sony as well my highlights they aren't super cyclical it's not like nintendo how they have one truly successful platform and all of a sudden it's a completely different business

um it i so i guess it's not really that impacted by um like hit driven events but i'll bet most people do buy the digital only ps5 and that should help margins at least in the gaming business right and potentially the business at large my low lights though it's lumpy and really unpredictable the stock declined for three years after launching the ps4 which keep in mind was the fourth best-selling console of all time it's hard for a big business like this to grow there's a ton of different moving parts, even huge console launches hardly move the needle for them. And that doesn't mean that they can't return value to shareholders through improved cost structures. But for reference, over the last 15 years, revenue has declined 7% or at best is flat.

And you can pick out independent points in time, but it's super lumpy. And I guess this will lean into our next question. I have no idea what the financials will look like next year. yeah i mean well it could i don't know if you i think there's a floor there's a high floor because it's not like every business is going to go away but yeah it's tough to analyze you really got to dig in and it might take a month uh to fully understand this business uh so last question here are we more interested or less interested in sony after today i'm not very interested in this company because of the lack of predictability on my part i can't i like a company where you can say all right they have you know a b and c going for them that should drive revenue should lead to

sustainable growth and might change the margin structure or the pro the margin profile for the business it's hard for me to tell like even if ps5 is a total hit and the software downloads change the video gaming margins yeah they they could have a total drop off in electronic sales and basically be flat so it's really unpredictable on my side and that's not something i like to see yeah i'm gonna say the opposite i'm more interested not i do agree with your points there but the valuation intrigues me because i do think they have a high floor and that sony is going to be able to generate lots of cash flow for years to come it's not gonna likely grow that much but that's the conundrum you get into here like if you could invest in a high growth company trading at

100 times cash flow or do you want to invest in a company trading at less than 10 times cash flow you know you have to weigh those odds um and i don't know i'm not an expert in sony's business i definitely have to read up more on them but i i am interested and i i would take a look especially at this valuation it is worth noting they've been trade i last year or two years ago they had a free cash flow multiple about half of what they have now so they have had a bit of a run-up in the stock price as of late yeah yeah just because the cash flow multiple is fairly low um comparatively it doesn't mean it can go low or can't go lower right all right that's going to do it for this episode guys thank you for listening make sure to follow us on twitter as always at chit chat

money and email us at chit chat money podcast at gmail.com for show suggestions we love those remember we are not financial advisors anything we say on this show is not formal advice or recommendation thank you for listening we'll see you on our next episode Thank you. We'll be right back.