Sonos: An interesting business with growth ahead.
Sonos is one of the world's leading brands in the global audio market. Like most other stocks, the stock price of Sonos has dived in 2022 due to factors I will cover later in this analysis. Sonos has an interesting business model, and management is convinced that the company will continue to grow. Does the 2022 drop in the share price mean that Sonos is now a buy?
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 start with the analysis, I should mention that I do not currently own shares in Sonos, meaning that I have no skin in the game when it comes to the company. If you would like to see or copy my portfolio, you can read how to access it here. As always, I will keep this analysis unbiased.
Sonos is an American developer and manufacturer of audio products best known for its multi-room audio products that was founded in 2002. Sonos has an interesting business model in which they refer to the Sonos flywheel. The flywheel means that once Sonos acquire new customers, which they refer to as households, these households do two things. The first is that they usually add more products to their homes (in fiscal 2022, the average household has 2,98 products which is up from 2,95 in fiscal 2021), and the other is that they become advocates for Sono's products that helps Sonos acquiring new customers. Sonos generate their 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 that gives freedom to the consumers. In my opinion all of this is tired to the Sonos brand, which means that Sonos has a brand moat.
Their CEO is Patrick Spence. He joined Sonos as CCO in 2012 and became the CEO in 2017. Before joining Sonos Patrick Spence held different roles at RIM/BlackBerry. He holds an Honors Degree in Business and Administration from the Richard Ivery School of Business at the University of Western Ontario in Canada. Since he became CEO of Sonos the company has experienced a huge growth, and Sonos has gone from exclusively having hardware products to monetizing services, such as Sonos Radio HD. He has described great leadership to 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, in which he took 20 % pay cut that he later extended. He has also been very verbal regarding his concern about the dominance of companies like Google and Apple that he means is squeezing competition, which results in 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 seems to be liked by the employees, as he scores an 84-employee rating at Comparably, which puts him in top 5 % of CEOs in similar sized businesses, while also getting good reviews at Glassdoor. Based on his leadership, experience, and innovation, I feel confident Patrick Spence being the right person to move Sonos in the right direction.
I believe that Sonos has a brand moat. I really like the management as well. Later I will do a discounted cash flow model to calculate a price for Sonos but before I do so, let us just have a look at some key financial metrics.
Down below we see some key financial metrics Sonos over the last three years. Sonos's fiscal year ends in September, meaning the 2022 numbers is a 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 2021, which results in lower gross profit margin, which isn't good. Looking at the operating margin, it is concerning that it has decreased this much from 2021 to 2022 and is something that will need to monitored moving forward. Later in the analysis, I will mention why operating margin has increased as it has. Net Income, EBITDA, and EBIT all decrease from 2021 to 2022, which is obviously not a good thing. However, it is nice to see that Sonos is still a profitable company. Moving forward, I would like to see years like 2021 and not like 2022.
Before we continue to the discounted cashflow model, I would like to investigate the risks and potential of Sonos. One risk is higher costs. The reason that margins were down from 2021 to 2022 is that Sonos has experienced higher costs in such as labor, freight, and raw materials. While it seems like freight is slowly getting normalized, and Sonos no longer has to use air freight, prices are still elevated. With inflation soaring around the world, I don't expect that labor costs or the costs on raw materials will dramatically drop any time soon, which will impact the margins, meaning that Sonos will be less profitable in the short-term. Another risk is macroeconomics. As the world may be looking into economic headwinds, it could result in in consumers spending less on products like Sonos, as they will need to make sure they afford essentials. Another macroeconomic factor that affects Sonos short term is foreign exchange headwinds. In the latest earnings call, management mentioned that the stronger dollar to create a $79 million foreign exchange headwind in fiscal 2023. The final risk I want to go through 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 has. Hence, competition will always be a risk factor for a company like Sonos.
There are also potential for Sonos moving forward. Large addressable market. Management believes that Sonos is still in early innings of their growth. They mentioned that Sonos has an installed base of Sonos households of 14 million in fiscal 2022, while the total addressable core market is 158 million households. It means that Sonos has currently only reached 9 % of their potential households. More products per household. As I wrote earlier, the average of Sonos' households owns 2,98 Sonos products. 40 % of the households only own 1 Sonos product, meaning that there are still plenty of households that should be expected to buy more Sonos products. Furthermore, management believes that in the future, every mature Sonos household will own between 4-6 Sonos products, which means that increasing products per household represents a $5 billion revenue opportunity according to management. Expansion of Direct to Consumer and Installer Solutions. Sonos wants to make direct to consumer sales and staller solutions a larger part of the revenue. In fiscal 2023, these two segments accounted for 44 % of the business, which was up 260 basis points from the year before. These two segments carry higher gross margins than retail sales, which will improve the profitability of Sonos. Management expects that the shift towards these segments will continue in fiscal 2023, which will result in higher revenue per product than they have seen in recent years.
I have now investigated the financials, risks, and potential of Sonos. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2022 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 3 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with an option in the middle. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the current market conditions. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to use an EBIT growth of 15 % year over year. It might be too high for some and too low for others. The EBIT growth forecast at Finbox is around 27 % over the next 4 years but that is included a very strong 2024. I feel more comfortable in the 15 %. I calculated with a growth in Depreciation & Amortization of 13 % a year, which has been the average the last 5 years. Finally, I decided to 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 to be $26.
Having investigated Sonos, I find the company interesting. I believe they have an interesting business model, and if management is right with their estimates, Sonos still have a lot of potential to grow. However, I believe that Sonos is facing some short-term risks due to macroeconomic factors, which means that Sonos will face some challenging quarters, which could put pressure on the stock price. Long-term though, I think that Sonos will prevail, especially if they can expand their high margin businesses, which I think management will be able to do. I will probably stay clear of Sonos for the time being because of macroeconomics but if someone buys it below $13, which is 50 % discount on intrinsic value, I will understand.
My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how I do it, you can read this post.
I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.
Some of the greatest investors in the world believe in karma, and in order to receive, you will have to give (Warren Buffett and Mohnish Pabrai are great examples). If you appreciated my analysis and want to get some good karma, I would kindly ask you to donate a bit to Rolda Animal Rescue. It is an organization that is helping the animals in Ukraine, and they need all the help they can get. If you have a little to spare, please donate here. Even a little will make a huge difference to save these wonderful animals. Thank you.