Fitch: Sony's Profitability Remains Fragile
Fitch Ratings says Sony's financial results for the third quarter of the financial year ending March 2013 (Q3FYE13) revealed fragile profitability notwithstanding benefits associated with the peak season for the sale of electronics products and the yen beginning to weaken during the quarter. Fitch maintains its Negative Outlook, and believes that the company's ratings hinge on the profitability and cash flow of its electronics businesses and debt reduction.
Over the next 12 months a weaker yen, particularly against the euro, may help improve profitability and possibly lead to a stabilization of the outlook if it helps EBIT margins excluding Sony Financial Holdings (SFH) rise above 1%. However, rationalizing its diverse operation, regaining lost technological leadership and successfully releasing "must-have" products will be more important over the long term.
Sony's operating profit totalled JPY47bn in Q3FYE13. However, when excluding SFH, operating profit was only JPY11bn, albeit a recovery from Q3FYE12's operating loss of JPY17bn, and implies a very thin operating margin of 0.7%.
The improvement was driven by cost reductions following the restructuring of its TV business and a stronger contribution by its entertainment business during the quarter. Nevertheless Sony's entertainment business remains volatile and cannot be relied upon to continually offset operating losses in the electronics business segment, in Fitch's view. Moreover, Fitch is also concerned that gross debt, excluding SFH, increased by a further 8.8% quarter-on-quarter to JPY1,363bn in December 2012.
Sony's electronics businesses continue to face a tough environment due to stronger competition and substitution from smartphones and tablets. The core problem for Sony is a failure to create "must-have" products and deterioration in the perception of the brand, relative to Korean manufacturers in particular.
While the re-launch of its smartphone business since the beginning of FYE13 helped regain market share slightly, Sony's smartphone business has yet to gain sufficient traction. Its market position is still substantially behind Samsung Electronics Co., Ltd. ('A+'/Stable) and Apple, and even below Chinese vendor, Huawei, in Q3FYE13, according to IDC data. Its Mobile Products & Communications segment also made a substantial operating loss of JPY21bn in Q3FYE13. In addition, future growth in its smartphone business may be at the expense of its other products, including digital cameras, video cameras, game devices, PCs, and digital audio players.
Excluding SFH and the entertainment businesses, the electronics businesses recorded a high operating loss (including losses from affiliated companies) of JPY30bn in Q3FYE13, versus a JPY17bn loss in Q2FYE13. Recovery in profitability was hampered due to further weakness in its Imaging Products & Solutions segment, its Game segment, as well as on-going substantial losses in its Mobile Products & Communications segment.
Fitch expects these trends to continue during the next few quarters, and believes that meaningful recovery will be slow, given Sony's loss of technology leadership in key products and high competition.
Fitch views the weakening of the yen as a positive factor for Sony. The recent weakening yen is expected to raise operating income by JPY17bn in Q4FYE13, according to Sony, if all else stays unchanged. Sony notes that a one-yen change in the exchange rate against the euro affects its operating income by JPY6bn, but a one-yen change in exchange rate against the US dollar is neutral to its operating income.
Excluding SFH, Fitch continues to expect operating EBIT margins to be negative or minimal and funds flow from operations (FFO)-adjusted leverage to be above 4x for FYE13 and FYE14. Significant recovery in FYE15 will depend on the success of the company's turnaround plan.
Fitch also notes that Sony's balance sheet, excluding SFH, remained weak. However, Sony maintains a strong liquidity profile with unrestricted cash of JPY561bn in December 2012, covering 129% of short-term debts, all excluding SFH. Sony also had JPY777bn unused committed line of credit facilities in December 2012.
Fitch may downgrade the rating if Sony's EBIT loss sustains and FFO-adjusted leverage rises above 4.5x (both excluding SFH). However, Fitch will consider revising the Outlook to Stable if EBIT margins improve to over 1% and FFO-adjusted leverage is sustained below 4x, both excluding SFH.