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Morningstar | Robust Demand of PS4 and Image Sensors will Compensate Sony for the Risk of Weaker Smartphone Sales

Sony’s September quarter operating income was JPY 240 billion, which is 25% above the previous year’s number, after excluding the impact of impairment loss on the mobile communications segment. Despite the number exceeding our forecast of JPY 210 billion, our impression of the results is somewhat mixed. We are encouraged with the robust sales of PlayStation 4 games/add-on contents and future demand for Sony’s image sensor seems to be larger than anticipated. However, we are concerned about the loss from the smartphone business is becoming much larger than our expectation as Sony is quickly losing market share and revenue growth of the mobile game, Fate/Grand Order, seems to be slowing down. Overall, we view these risks as being limited, and Sony’s earnings results are fairly in line with our long-term forecasts. We plan to update our numbers after visiting the company in November, but do not expect a material change to our fair value estimate of JPY 6,000.

Revenue for the game & network segment increased 27% from the previous year, mainly driven by the 56% growth of game revenue, including the add-on contents. We estimate that the smash hit of first-party games, such as God of War and Marvel’s Spider-Man, and add-on contents sales of the third-party game, Fortnite, contributed to the revenue growth. In addition, monthly subscription charge of PS Plus service has also increased, as subscribers in this quarter jumped to 34.3 million from 28.1 million on the previous year. We believe that Sony has established an ecosystem which mitigates the cyclicality of game consoles, as monthly subscription fee and add-on contents will deliver stable cash flow to the company.

Demand for the mobile image sensor is also tracking above our forecast, driven by the: 1) diffusion of multi-camera smartphones; 2) requirement of larger image sensors; and 3) higher resolution of front cameras. Therefore, Sony is now assessing the expansion plan of its production capacity by 20-30% by fiscal 2021. We estimate that Sony’s global market share on CMOS imaging sensor is 50-55%, and the expansion plan will contribute maintaining the advantage on both the production capacity and the sensing technology.

Meanwhile, Sony’s smartphone business seems to be falling off a cliff. Its unit shipment guidance was 10 million at the beginning of this fiscal year, but the company cut this number by 30% to 7 million units, because of the weaker demand in Europe. Accordingly, its operating loss guidance of Mobile Communication segment is revised to JPY 95 billion from JPY 15 billion, including JPY 16 billion impairment loss of intangible fixed assets. Sony estimates that the segment will record an operating loss for the next fiscal year too, as it needs to cut 50% of operating cost to improve its profitability, which takes some time. We view that most smartphone makers do not possess an economic moat, as and in fact, Sony’s leadership position in Japan is threatened by Sharp, and market share in overseas is taken away by Asian competitors, which suggests that intense competition on handsets will continue to be the risk factor for Sony.