Sonos (NASDAQ: SONO) is the world’s leading sound experience company, and they provide industry leading sound and home theater systems. They are known for high quality products, and customers love them. Also, their customers are known for being vocal about Sonos products on social media and bragging about owning their home theater system when guests visit their houses. Also, CE Pro magazine gave Sonos’ wireless speakers, sound bars, and subwoofer top rankings in 2021.
Sonos’ revenue grew rapidly during the pandemic as many people upgraded their home theater system. However, as we leave the pandemic, investors worry about Sonos’ growth prospects, causing stock price to suffer in 2021. Also, the recent market wide sell-off further hurt their stock price. However, I think labeling Sonos as a pandemic stock is a mistake, and the current price level presents a great opportunity for long term investors because:
- They had record 1Q 2022 results, and easily beat the market estimation on both revenue and profit.
- Sonos’ business model allows customers to buy one product initially and then add more components later. This business model is showing great success at building in additional growth, and I expect this will continue.
- The superb product, brand recognition, and customer loyalty provide a great economic moat for Sonos, giving substantial profitability.
Strong 1Q 2022 Result
Sonos reported 1Q 2022 results in early February, and it was a great result. The revenue of $ 664 M beat the estimate by $ 27 M, and the EPS of $ 1.02 beat the estimate by $ 0.04. More importantly, management provided upbeat guidance for 2022 revenue. They expect 2022 revenue to be between $ 1.95 B and $ 2.0 B, which represents 14-16% YoY growth. Also, they reiterated their 2024 target of $ 2.5B, representing 13-15% CAGR from this year.
This strong performance and upbeat future guidance give a clear indication that the market labeling them as a “pandemic stock” was incorrect. Certainly, the 2021 revenue growth of 23% was a bumper result assisted by the pandemic environment, and the future growth will be closer to the historic average (12-13%). Yet this is still respectable growth. Therefore, the market’s punishment of the stock (35% drop relative to 12 months ago) was an overreaction. They are overestimating the slow-down in revenue growth, and underestimating Sonos’ economic moat.
Furthermore, there is still plenty of market opportunity for Sonos. At this point, they have only penetrated 9% of the Core market (developed countries in North America and Europe), and they have barely scratched the surface in other regions. During 1Q 2022, the most significant growth came from the Asia Pacific Region (18% YoY Growth). Given this large addressable market, and increasing popularity of Sonos products overseas, I expect Sonos’ growth to continue for the foreseeable future.
Built-In Growth Model
The business model of Sonos has built-in growth. Their platform allows customers to start with a small set of products and keep adding more components in the future. This built-in growth model is working great for Sonos, and the effect is demonstrated by a graph showing the average products per household over time. Sonos customers clearly love their products and add more over time.
Also, Sonos’ customers are known to be vocal and proud of owning Sonos. They like to show their home theater system to household visitors. These free brand ambassadors play a huge role in building brand recognition, and also decreasing Sonos’ marketing cost of average new household acquisition.
During the last earnings call, the CEO mentioned that 46% of their existing households came back to add more Sonos products in 2021, representing one of the strongest customer loyalty rates in the industry. He mentioned that this repurchase behavior is unique and forms a critical element of their growth. New product lines like Beam Gen 2 (newest version of compact smart soundbar for TV, music, and gaming) are also being introduced, and I expect they will further fuel growth in the future.
Strong Profitability and Strong Cash Flow
Reflecting Sonos’ strong economic moat created by a superb product, customer loyalty, and brand awareness, their profitability is well above that of peers. Their gross profit margin (47.70%) and net income margin (8.63%) are well above the median sector. Most notable figures are their return on equity, return on total capital, and return on total assets. These figures are 45-90% higher than the industry average, which demonstrates the strength of their economic moat and the efficiency of management in deploying their capital and resources.
Thanks to this high profitability and increasing revenue, Sonos generated plenty of cash flow during 1Q 2022. They generated $ 180 M cash from operation and $ 174 M in free cash flow. This strong cash flow generation will allow them to keep developing new products and putting resources towards expanding their market. Also, they have a strong balance sheet with a negative net debt position (- $ 710 M), which means they have more cash than debt), and high liquidity (current ratio at 1.94x).
Intrinsic Value Estimation
I used the DCF model to estimate the intrinsic value of Sonos. For the estimation, I utilized EBITDA ($ 196.4 M) as a cash flow proxy and the current WACC of 8.0% as the discount rate. For the base case, I assumed EBITDA growth of 14% (lower end of management revenue guidance) for the next 5 years and zero growth afterwards (zero terminal growth). For the bullish and very bullish case, I assumed EBITDA growth of 16% and 18%, respectively, for the next 5 years and zero growth afterwards. Given their economic moat and growth trajectory, I believe achieving 14-18% growth is certainly within reach. Note that their 5 year average EBITDA growth has been 31.54%, so I believe 14-18% is certainly achievable, and may even fall at the lower end of the projection.
The estimation revealed that the current stock price represents 20-40% upside. Their loyal customer base, best in class products, and built-in growth model will all contribute to future growth, and I expect them to achieve this upside.
Very Bullish Case
The assumptions and data used for the price target estimation are summarized below:
- WACC: 8.0%
- EBITDA Growth Rate: 14% (Base Case), 16% (Bullish Case), 18% (Very Bullish Case)
- Current EBITDA: $ 196.4 M
- Current Stock Price: $ 24.71 (03/10/2022)
- Tax rate: 20%
There is currently an industry wide part shortage. Due to these challenges, companies are not able to manufacture enough products to meet the demand. Specifically, Sonos experienced a 5% YoY revenue decrease in the Speaker division. There are signs that supply chain disruptions are easing, and this trend will certainly help to alleviate this component shortage, but this is an indicator to watch going forward.
Sonos products are definitely not essential items, but instead are discretionary. We are all aware of the many uncertainties around the world, and some economies are expecting a potential recession due to high inflation and energy costs. If that happens, Sonos’ revenue growth would be negatively impacted as people will reduce their discretionary budget. Therefore, the investor should monitor the macroeconomic indicators.
Sonos has been the leading home theater system company for a while, and I expect them to maintain this leadership position for the foreseeable future. They have superb products, and customers simply love their components. Given their addressable market and the built-in growth in their business model, I expect their revenue to continue to grow into the future. The component shortages and negative market sentiment may challenge Sonos, but the company has a strong balance sheet and cash flow to handle the situation. I think 20-40% upside is warranted.