Sonos: A Promising Business with Growth Potential.
Opdateret: 7. aug.
Sonos is one of the world's leading brands in the global audio market. Like many other companies, Sonos had its problems in 2022 due to factors that will be covered later in the analysis. The stock of Sonos has remained relatively flat in 2023, thus it has not performed as well as the major indices. Nonetheless, Sonos has an interesting business model, and management is convinced that the company will continue to grow. Does the drop in Sonos' share price mean that it is now a good investment?
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
This analysis will be a bit different from what you are used to read in my blog. Sonos did their IPO in August 2018, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.
Before I begin the analysis, I should mention that I do not currently own any shares in Sonos. This means that I have no personal stake in the company. If you would like to view or make a copy of my portfolio, you can find instructions onhow to access it here. As always, I will keep this analysis unbiased. If you want to buy shares or fractional shares in Sonos, you can do so through eToro. eToro is a highly user-friendly platform, allowing you to begin with just $50.
Sonos is an American developer and manufacturer of audio products, best known for its multi-room audio systems. The company was founded in 2002. Sonos has an interesting business model in which they refer to the Sonos Flywheel. The flywheel means that once Sonos acquires new customers, which they refer to as households, these households do two things. The first reason is that households typically add more products to their homes. In fiscal year 2022, the average household had 2,98 products, an increase from 2,95 in fiscal year 2021. The second reason is that they become advocates for Sonos' products, which helps Sonos acquire new customers. Sonos generates its income through three segments: Retail and Other, Direct to Consumers, and Installer Solutions. In their annual report, Sonos lists their competitive strengths, such as having a leading sound system, the Sonos app, and their partner network, which provides freedom to consumers. In my opinion, all of this is tied to the Sonos brand, which means that Sonos has a brand moat.
Their CEO is Patrick Spence. He joined Sonos as the Chief Commercial Officer (CCO) in 2012 and became the Chief Executive Officer (CEO) in 2017. Before joining Sonos, Patrick Spence held various roles at RIM/BlackBerry. He holds an Honors Degree in Business Administration from the Richard Ivey School of Business at the University of Western Ontario in Canada. Since becoming CEO of Sonos, the company has experienced tremendous growth. Sonos has transitioned from solely offering hardware products to also monetizing services, including Sonos Radio HD. He has described great leadership as not being involved in everything, but instead having the right people in the right places. He also tried to lead by example, which was shown during the pandemic when he took a 20% pay cut that he later extended.He has also been very vocal about his concern regarding the dominance of companies like Google and Apple, which he believes is stifling competition and suppressing new ideas. He has previously been named as one of Canada's top 40 under 40, which is a program that celebrates outstanding achievers, visionaries, and innovators in Canadian business. He also appears to be well-liked by the employees, as he has received an 84-employee rating at Comparably, which places him in the top 5% of CEOs in businesses of similar size. Additionally, he has received positive reviews on Glassdoor. Based on his leadership, experience, and innovation, I feel confident that Patrick Spence is the right person to move Sonos in the right direction.
I believe that Sonos has a strong brand moat. I really like the management too. Later, I will use a discounted cash flow model to calculate a price for Sonos. But before I do that, let's take a look at some key financial metrics.
Below, we will examine some key financial metrics for Sonos over the past three years. Sonos's fiscal year ends in September, meaning the 2022 numbers represent the period from October 1st, 2021, to September 30th, 2022. It is worth noticing that revenue has grown every year, which is always positive. However, we also see that the cost of revenue in 2022 is higher than in 2021, which results in a lower gross profit margin. This is not a favorable outcome. Looking at the operating margin, it is concerning that it has decreased this much from 2021 to 2022, and it is something that will need to be monitored moving forward. Later in the analysis, I will mention why the operating margin has increased as it has. Net income, EBITDA, and EBIT all decrease from 2021 to 2022, which is clearly unfavorable. However, it is nice to see that Sonos is still a profitable company. Moving forward, I would like to see more years like 2021 and fewer like 2022.
Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of Sonos. One risk is higher costs. The reason for the decrease in margins from 2021 to 2022 is that Sonos has experienced higher costs in areas such as labor, freight, and raw materials. While it seems like freight is slowly returning to normal, and Sonos no longer has to rely on air freight, prices are still high. With high inflation around the world, I don't expect labor costs or the costs of raw materials to dramatically drop any time soon. This will impact the margins and result in Sonos being less profitable in the short-term. Another risk is macroeconomics. As the world may be facing economic headwinds, consumers may start spending less on products like Sonos, as they will need to prioritize essential expenses. Another macroeconomic factor that affects Sonos in the short term is foreign exchange headwinds. In the latest earnings call, management mentioned that the stronger dollar is expected to create a $79 million foreign exchange headwind in fiscal 2023. The final risk I want to discuss here is competition. Sonos is competing against some of the largest companies in the world, such as Amazon, Apple, Google, Sony, and Samsung. These companies have much greater financial, technical, and marketing resources available to them than Sonos does. Hence, competition will always be a risk factor for a company like Sonos.
There are also potential opportunities for Sonos moving forward. A large addressable market. Management believes that Sonos is still in the early stages of their growth. They mentioned that Sonos had an installed base of 14 million Sonos households in fiscal year 2022, while the total addressable core market is 158 million households. Thus, Sonos has currently only reached 9% of their potential households. More products per household. As I mentioned earlier, the average Sonos household owns 2,98 Sonos products. 40% of households only own 1 Sonos product, indicating that there are still numerous households that are likely to purchase additional Sonos products. Furthermore, management believes that in the future, every mature Sonos household will own between 4-6 Sonos products. This indicates that increasing the number of products per household could potentially generate $5 billion in revenue, as estimated by management. Expansion of Direct-to-Consumer and Installer Solutions. Sonos wants to make direct-to-consumer sales and installersolutions a larger part of their revenue. In fiscal 2022, these two segments accounted for 44% of the business, which was an increase of 260 basis points from the previous year. These two segments carry higher gross margins than retail sales, which will improve Sonos' profitability. Management expects that the shift towards these segments will continue in fiscal 2023, which will result in higher revenue per product than what they have seen in recent years.
I have now investigated the financials, risks, and potential of Sonos. I will now examine the price by utilizing a discounted cash flow model. To do so, I will need some numbers that you can see below. The numbers are the 2022 figures, which I found on Finbox. However, I have determined the perpetuity growth rate and the discount rate myself. The reason I chose a 3% perpetuity growth rate is that it typically falls between the historical inflation rate of 2-3% and the historical GDP growth rate of 4-5%. I decided to go with a middle option. The chosen discount rate of 12% is because it falls within the typical range of 9-12%. I decided to go with the highest option due to the current market conditions. Remember that all the numbers used in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization, and Net Working Capital will change over the next couple of years. I decided to use an EBIT growth rate of 15% year over year. It might be too high for some and too low for others. The EBIT growth forecast at Finbox is projected to be around 27% over the next 4 years, but this includesa particularly strong performance in 2024. I feel more comfortable in the 15%. I calculated a 13% annual growth in Depreciation & Amortization, which has been the average over the past 5 years. Finally, I decided that Net Working Capital will grow at 10%. I haven't found a smart way to share all my spreadsheet here, but once I did my calculations, I found that the intrinsic value of Sonos is $26.
I find the company Sonos interesting after conducting an investigation. I believe they have an interesting business model, and if management is right with their estimates, Sonos still has a lot of potential to grow. However, I believe that Sonos is facing some short-term risks due to macroeconomic factors. This means that Sonos will experience challenging quarters, which could potentially put pressure on the stock price. Long-term, however, I believe that Sonos will prevail, particularlyif they can expand their high-margin businesses, a goal I think management will achieve. I will probably avoid investing in Sonos for now due to macroeconomic factors. However, if someone purchases it at a price below $13, which represents a 50% discount on its intrinsic value, I will understand.
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