Sonos is one of the world's leading brands in the global audio market. Like many other companies, Sonos faced challenges in fiscal years 2022 and 2023 due to factors that will be discussed later in the analysis. Nonetheless, Sonos has an interesting business model, and the management is convinced that the company will continue to grow. Is the decrease in Sonos' share price an indication 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 reading on my blog. Sonos conducted their IPO in August 2018, which means I do not have access to historical financial data predating that event. So, instead of applying the principles I learned from my Phil Town workshop, I now use the principles I learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis are from Finbox, which I believe is a great tool for easily obtaining the numbers you need from various companies.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Sonos. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Sonos' competitors either. Thus, I have no personal stake in Sonoss. If you want to purchase shares or fractional shares of Sonos, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Sonos is an American company that develops and manufactures audio products, best known for its multi-room audio systems. The company was founded in 2002. Sonos has an intriguing business model in which they refer to the Sonos Flywheel. The flywheel concept means that once Sonos acquires new customers, which they refer to as households, these households do two things. Firstly, households typically acquire more products for their homes. In fiscal year 2023, the average household had 3,05 products, an increase from 2,98 in fiscal year 2022. The second reason is that they become advocates for Sonos' products, which helps Sonos acquire new customers. This is evident from the fact that word of mouth is one of the top contributors to Sonos' household growth. Sonos generates revenue from sales of its speaker products, such as wireless speakers and home theater speakers, as well as from its system products, which mainly consist of component products. Additionally, Sonos earns revenue from partner products and other sources, including partnerships with IKEA and Sonance, third-party accessories, licensing, advertising, and subscription revenue from services like Sonos Radio HD and Sonos Pro. Sonos generates the majority of its revenue from the Americas, with approximately 63% of its revenue coming from this region. The United States contributes approximately 59% of the total revenue. The EMEA region contributes approximately 31% of the revenue, while the APAC region contributes approximately 6% of the revenue. Sonos has a brand moat, as evidenced by its ability to gain market share in fiscal 2023 despite competitors offering deep discounts throughout the year. This demonstrates Sonos's strong brand and loyal customer base.
Their CEO is Patrick Spence. He joined Sonos as the Chief Commercial Officer (CCO) in 2012 and was appointed as the Chief Executive Officer (CEO) in 2017. Before joining Sonos, Patrick Spence held various positions 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 assuming the role of CEO at Sonos, the company has experienced tremendous growth. Sonos has transitioned from solely offering hardware products to also monetizing services, such as 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, as demonstrated during the pandemic when he took a 20% pay cut, which he later extended. He has also been outspoken about his concern regarding the dominance of companies such as Google and Apple, which he believes is stifling competition and suppressing new ideas. He has previously been recognized as one of Canada's top 40 under 40, a program that honors exceptional achievers, visionaries, and innovators in Canadian business. He also seems to be well-liked by the employees, as evidenced by his 84-employee rating at Comparably, which ranks 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 am confident that Patrick Spence is the right person to lead Sonos in the right direction.
I believe that Sonos has a strong brand moat. I really like the management as well. Later, I will use a discounted cash flow model to calculate the price of Sonos. But before I do that, let's examine some essential financial metrics.
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Below, we will analyze some important financial metrics for Sonos over the past three years. Sonos's fiscal year ends in September, meaning the 2023 numbers represent the period from October 1, 2022, to September 30, 2023. Upon reviewing the numbers, it is evident that the past two years have been challenging for Sonos. Sonos managed to increase their revenue in the fiscal year 2022, but their profit margins decreased. The numbers were even worse in fiscal year 2023, with both revenue and margins decreasing, and operating income turning negative. These numbers are worrisome. It is worth noting that many companies have encountered challenges as a result of macroeconomic factors, such as high inflation. Management has acknowledged that they are aware of Sonos being in a downturn in the home audio business cycle due to the global economy. However, they are confident that consumers will eventually return. Thus, I wouldn't place too much emphasis on the numbers from the past two fiscal years. Instead, I would like to see revenue growth and improved margins in fiscal 2024, which aligns with Sonos' expectations as per their guidance.
Before we proceed with the discounted cash flow model, I would like to examine the risks and potential of Sonos. One risk is macroeconomics. Continued global economic uncertainty and reductions in consumer discretionary spending and consumer confidence may affect the sales of Sonos' products and services. The economic uncertainty has dampened consumer discretionary spending, leading to a challenging fiscal year for Sonos in 2023. Lower revenue and margins have resulted in the company being unprofitable for the first time since 2020. If global economic conditions continue to be volatile or economic uncertainty persists, it may lead consumers to delay or reduce purchases of Sonos products and services. As a result, consumer demand for our products and services may not grow as Sonos expects. Another risk is competition. Sonos is competing against some of the largest companies in the world, including Amazon, Apple, Google, Sony, and Samsung. These companies all have significant market share, diversified product lines, well-established supply and distribution systems, strong global brand recognition, and a loyal customer base. Furthermore, they have much greater financial, technical, and marketing resources available to them than Sonos does. Therefore, competition will always pose a risk for a company like Sonos. Continued innovation is necessary. Management has emphasized the critical importance of continuing to innovate and introduce new products to stimulate customer demand for new and upgraded products in both mature and developing markets. This is particularly crucial as new products often represent customers' first Sonos purchase. Thus, if Sonos wants to consistently expand its Flywheel, it is critical that they continue to introduce new popular products.
There are also potential opportunities for Sonos in the future. A large, addressable market. Management believes that Sonos is still in the early stages of its growth. Currently, Sonos only has a 2% share of the $100 billion global audio market and a 9% share of households in their markets, indicating ample room for growth. Sonos continues to gain market share due to its loyal customer base, who enthusiastically recommend the quality of Sonos products to their friends and family, leading to increased sales. It means that Sonos is able to gain market share without having to discount their products, unlike many others in the industry who have had to do so. It isn't a fluke but a business model that Sonos has used for 18 years. Thus, it seems that Sonos can continue to gain a larger share of the sizable addressable market. More products per household. As I mentioned earlier, the average Sonos household owns 3,05 Sonos products. Currently, 40% of households consist of a single product, while the average multi-product Sonos household has 4,4 products. Sonos believes that the average multi-product household can expand to 6 products. If this occurs, it is estimated to represent a $6 billion revenue opportunity for Sonos. Furthermore, the revenue per product sold increased by 4% in fiscal year 2023, and had also increased significantly the year before. Sonos expects the trend of increased revenue per product to continue in the future. Exciting new product launch scheduled for fiscal 2024. Management has announced plans to launch a significant product in a new multi-billion dollar category. This product will complement their current offerings, excite customers, and generate immediate revenue in the second half of fiscal year 2024. Management expects to generate over $100 million from new product introductions this year, with this exciting new product accounting for a significant portion of this revenue in the second half. This indicates that this product will have immediate benefits for Sonos' business. We still don't know what the product is, but it is encouraging that Sonos will be launching a new product in a new category that will have immediate benefits for their business.
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I have now investigated the financials, risks, and potential of Sonos. I will now analyze the price using a discounted cash flow model. To do this, I will need some numbers, which you can see below. The numbers represent the 2023 figures, which I found on Finbox. However, I have calculated 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 choose a middle option. The chosen discount rate of 12% falls within the typical range of 9-12%, which is why it was selected. I decided to choose the highest option because of the current market conditions. Remember that all the numbers used in these calculations are in millions.
I also need to determine the expected changes in EBIT, Depreciation & Amortization, and Net Working Capital over the next couple of years. I decided to use an EBIT growth rate of 24% year over year because the average EBIT growth in the past five years has been 24%. The growth in depreciation and amortization has also been 24%, which is why I use the same number. Finally, I have decided that the Net Working Capital will grow at 6%, as estimated by Finbox. I haven't found a convenient way to share all my spreadsheet here, but once I completed my calculations, I found that the intrinsic value of Sonos shares is $9. However, these calculations are based on a very poor fiscal 2023. Sonos expects that they are currently in a downturn of the business cycle and anticipates improvement in the future. When I calculated the intrinsic value based on the fiscal 2022 numbers, it was $26.
I believe that Sonos is an interesting company with effective management. Sonos is currently facing short-term risks due to global economic uncertainty, which has contributed to its poor performance over the past two years. However, the management appears confident that the company is currently experiencing a downturn in the business cycle and anticipates improvement in the future. Competition will always pose a risk for Sonos as it competes with some of the world's leading companies. However, Sonos has performed well thus far, and with strong brand loyalty among its customers, I believe they will continue to do so, provided they continue to launch new and interesting products. It is critical for Sonos' business to continue innovating and launching new products, as they have done historically. So, while I believe that Sonos will continue to perform well, it is important to monitor this if considering an investment in Sonos. I believe there are many great things about Sonos. I appreciate the fact that their customers keep purchasing more products, leading to an increase in the average products per household year over year. Sonos also has a large potential market and continues to gain market share, which is very positive. Finally, Sonos will launch a product in fiscal 2024. This launch will not only have an immediate effect on the business, but it will also provide long-term benefits as it gives Sonos exposure to a new multi-billion dollar category. I typically prefer to invest in profitable companies, but if Sonos shares drop below $9, I will consider opening a small position as I believe the potential rewards will outweigh the risks.
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