Sony (SONY) reported better than expected 1Q22 earnings and raised full-year guidance.  We had thought that guidance was conservative, both short-term and long-term, so the news was not surprising.  It is welcome news in support of the long-term investment thesis that SONY’s individual business are deeply undervalued compared to peers with a management team that has executed well strategically, operationally, and financially to remake the company over the past five years.  Northlake continues to see SONY shares as deeply undervalued and is willing to exercise patience given the high-quality assets on the balance sheet and conservative corporate culture.

Stock Reaction:  SONY shares had a minimal reaction to the good news.  The stock has moved mostly sideways in a wide band since we purchased it for client accounts earlier this year.  SONY has significant exposure to video games; stocks in that sector had a tough week when SONY reported.  We believe that limited the upside in SONY shares despite the “beat and raise” quarter.  Beat and raise usually gets a positive reaction from traders.

Earnings Analysis:  SONY reported its highest ever operating income in 1Q22 led by Music, Electronic Products, and Image Sensors.  Games were down against the tough COVID-boosted year-ago quarter but operating income at this segment was the second-highest ever, trailing only the June quarter of 2020.  Sony Music is the second-largest music label in the world and continues to leverage growth in music streaming and the expansion of music licensing to services like Facebook and Peloton.  Electronic Products is mostly a margin story as management has narrowed the product focus to premium TVs and cameras and worked hard to reduce costs.  Image Sensors are used in high-end mobile phones where demand for 5G is driving a replacement cycle offset by loss of sales of Huawei, China’s largest cellphone manufacturer, due to government boycotts.  SONY’s film business is still recovering from COVID-driven theater shutdowns.  The guidance increase after just one quarter of a new fiscal year is unusual for SONY.  Most of the upside is coming from Music and Electronic Products.  We next see upside at Games where comparisons are easing and thus far engagement trends are holding up better than feared against 2020’s stay-at-home environment.

Target Price:  We continue to have a $145 target price on SONY.  The company is focused on music, video games, image sensors (semiconductors), and film and TV production.  Many peers focused solely on any of these businesses trade at multiples well above where SONY trades.  We understand the need to apply a conglomerate discount and a further discount that accounts for the conservative culture of Japanese corporations.  However, we believe the current discounted valuation is too steep and fails to reward the current management team for its superior execution and its successful efforts to change the culture of the company toward a more Western style.  For the shares to work, there must be improved sentiment toward video games and film and TV and improved comparisons in image sensors.  We see each of these things developing over the coming six to twelve months and are willing to be patient given SONY’s severely discounted valuation, financial strength, and superior management team.

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.