Sony's net income has been decreasing over the last five years. Most of Sony's earnings come from consumer driven markets (electronics, movies, music, etc. ). Its earnings are greatly affected by downturns in the economy. Its earnings follow the S&P 500 and have done a little better than this index over time. Of course past performance does not predict future earnings, but the trend seems to be consistent over time. When the economy was doing well in the late 90's Sony's stock did very well, the opposite is also true (See graph of comparison of S&P 500 over time)[IQ6].
In this climate Sony has decided to under go a reformation in order to remain a youthful and energetic company. This restructuring plan is referred to as, "Transformation 60" (TR60)2 and is scheduled to be complete in 2006. It is difficult to tell exactly how this has been affecting sales, since upper management is generally responsible for aligning a company's interests to head in the "best" direction, but the consistency of the ratios over the last five years seem to indicate that they feel that they are on the right track.
They have not made spontaneous changes to their strategic decisions that affect current performance. One indication that they have left day-to-day management to higher-level middle management is the decline in the cost of goods sold (COGS) (see Exhibit #). Sony's ROE has fallen in the last 5 years from 5. 6 in 2000 to 3. 8% in 2004. 3 This declining ROE could possibly mean that the new investments in R&D have not yet paid off and it will take longer to see the affects of this investment.
One unusual factor is that the LTD to Equity ratio has risen slightly over the last five years, which normally means that we should see an increase in ROE. However, this ROE is still a reasonable level when compared to the industry level of 3. 9%4 and should not be a major cause of concern as the debt is tied to their investments in research and development.. The Asset Turnover has been declining over the last several years. It has decreased on an average of 4. 5% per year for the last 5 years.
As explained above for the decreasing ROE this could be a consequence of their investments into new products not paying off affecting sales. Growth Analysis The growth rates and correlation analysis indicates that Sony's growth is at risk in the short term due to a dramatic decrease in Earnings per Share, Dividend per Share, and Share Price over the next five years. This analysis also indicates that both the internal growth rate and the sustainable growth has been decreasing over the past five years and are now at very low levels, 0. 3% and 1. 2% respectively.
However, the analysis shows a 13.94%6 growth in sales over the last five years and forecasts a continued increase in sales through 2009. The balance sheet looks fine given the modest debt (see ##). The primary objective for Sony is to heavily invest in research and development. This objective will not allow for Sony to see quick improvements in regards to their net income in the short term but their development plans will enable them to see the desired returns in the next couple of years. This will not yield a quick improvement in net income in the short term, but it should position them for future gains.
Until the restructuring plan is complete, the financial ramifications of this plan have diminished, or the economy in the United States turns, Sony will continue to see an average or declining ROE and thus its share price will also stay average or decline. Bankruptcy Risk In the Altman analysis, Sony's Z score is deteriorating. 7 In 2000 the score, 3. 44, was well over the threshold of 2. 67 but in years 2001-2003 the score dipped below the threshold of 2. 67 and in the most recent year the Z score is 1. 66.
All of the variables used in this calculation: Liquidity, Profitability, Earning Power of Assets, Leverage, and Activity; have all been decreasing over the last five years for Sony. The liquidity score is currently at . 05 which indicates that Sony may start experiencing problems covering their short-term obligations. The liquidity score is currently at 0. 05 this indicates that Sony may start experiencing problems covering their short-term obligations. The cumulative profitability score has seen a 0. 09 decrease from 2000 to the most current period.
The decrease in the earning power of assets score signifies that Sony is not able to generate as many profits from its assets as it once was. The leverage score in 2000 was 1. 7, and in the most current period the score is 0. 36. This indicates that if Sony were to become insolvent, their market share, before liabilities would exceed assets, and would quickly decline. The activity score has decreased over the last five periods as well; however, the decrease is notn't significant which represents that Sony is still managing their competition well and is efficiently using their assets to generate sales.
Sony's strong market share is also another factor that is helping the activity score to remain steady. According to Altman, Sony has a very high probability of becoming bankrupt. Although there are exceptions to this rule, this score does cause some concern as to the financial future of Sony. Regression The regression analysis8 provides some additional information in regards to the risk of investing in Sony. For instance, the beta is 1. 16. which This implies that since the beta is greater than one, the stock will be more volatile than the market and therefore bears more risk but could garner a greater reward.
In comparison to the industry beta of 1. 03, Sony is higher than the average; however, one of their competitors, Philips Electronics, has a higher beta of 1. 65. The total risk value displayed in the regression is 0. 0187. The systematic portion of this value only constitutes 17% meaning that the remaining portion, 83%, represents the unsystematic component. The R Squared is pretty low (0. 1699) which is an indication that our regression is not a good fit for predictability and that the percentage of variation that can be explained by the market is low as well.
The alpha in the regression was -0. 25% which correctly indicates that the stock price has been falling. The reasons for this negative alpha as well as discovering the keys to offsetting the unsystematic risk will be covered in the next section. Risk Analysis The markets that Sony is involved in are undergoing dramatic changes. The consumer electronics industry is seeing rapid advances in semiconductor technologies. There is also more competition now than before, and new participants are emerging from China, India, and Russia driving margins down.
The customers are also becoming more diverse and all of these changes will only continue to accelerate. In order to better adapt to the changing markets Sony is working to streamline operations with their TR60 "reformation" plan. Sony believes that this plan will enable them to withstand dramatic shifts in business conditions by becoming a leaner organization that will be more responsive to change. This plan has been in place for a couple of years which has caused their financials to suffer due to the large amount of early retirement packages that they have incurred by letting go 9,0009 employees.
These employees were mainly from Japan, Western Europe, and the U. S. TR60 has two central purposes, to enhance the operational profitability and growth strategy. The first goal of enhancing operational profitability is being realized by cutting fixed costs through downsizing the workforce and consolidating the manufacturing, distribution and customer service facilities. Sony is also looking at reducing variable costs by reassessing the strategy for procuring production materials.
The second goal, growth strategy, focuses on the core business of home electronics, mobile electronics, and entertainment. TR60 is a significant risk to the future of Sony since it is not known how long this restructuring will take until they find the right balance; . Ttherefore, the outcome is unpredictable. For instance, the plan could take longer to implement and be more costly than originally planned. A potential investor needs to watch this plan very closely to see if it does in fact make Sony more profitable and more responsive to the global consumers market.