Sony (SONY) reported another string of good quarterly results for 3Q21.  As was the case after each of the last two quarters, the company raised guidance for its FY21 ending March 22.  Strength was seen across most of the company’s diverse businesses with the biggest upside at Pictures (movie and TV production).  We still think guidance is low and the outlook for the next few years remains for above-average revenue, earnings, and profit growth.

Stock Reaction:  Initially, SONY shares popped about 5%, but those gains receded to a small loss by the end of first trading day after the report.  We suspect that the combination of a weak day for growth stocks other than Alphabet and the fact that most of the earnings upside came from the difficult-to-model Pictures segment were the culprits.  We little worry about the stock reaction and see reasons for increased optimism long-term.

Earnings Analysis:  SONY produced the new Spiderman movie which is one of the biggest box office hits of all time.  The company also had a big success (even by pre-pandemic standards) with the latest in the Venom series that is part of the Spiderman franchise.  These two films drove a big earnings beat for the Pictures segment even against high expectations.  SONY also had surprisingly good results in Image Sensors, Consumer Electronics, and Gaming despite all three areas being called out as having lost material sales to supply chain issues.  For example, the company noted that unit sales of PS5 could not nearly meet demand.  We view sales in these areas as deferred and think the outlook for next fiscal year will now get an added boost especially from the PS5 gaming console.  In all three segments, operating profits performed well despite the sales shortfalls.  For example, Gaming saw an 11% dip in sales but grew operating income by 13%.  This is a testament to SONY’s superior management team.  Overall, there is little to complain about in the latest results and updated guidance.

This was the first quarterly report since Microsoft announced its acquisition of Activison Blizzard and Sony announced the much smaller – but still significant – acquisition of Bungie.  Management was pretty tight lipped about both deals but has little concern about the prospect that Microsoft would move Activision’s massive Call of Duty game to exclusively Xbox.  We agree, at least for the next several installments of Call of Duty that are contractually committed to PlayStation.  SONY shares have been weak since the Microsoft-Activison merger announcement. We believe the coming pickup in PS5 sales, a series of new first-party games, and the upside from Bungie’s big hit Destiny 2 should put those fears to bed over the next few quarters.  We also like the live services technology that Bungie provides as a way to add upside to many of Sony’s current hit video games.

Target Price:  We stick with our $155 target price for SONY based on the upcoming fiscal year.  As noted above, it should be a strong year with upside to current analyst estimates.  We like SONY’s positions as market leaders in video games, music, movies and TV, and image sensors.  Pure play competitors in each of these businesses trade at multiples well above where SONY trades.  We get the conglomerate discount but SONY management has executed well both operationally and strategically and deserves more credit.  Maybe the increasing integration across the company’s consumer-facing businesses will lead investors to reduce the complexity discount.  SONY has the potential for a flywheel similar to Disney across its video game, music, and movie intellectual property.  The flywheel is a focus of management and we hope to see more Spiderman-like successes in the next year or two.

SONY is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.