Forget Apple, This Rival Is a Much Better Bargain

When assessing any stock, you need to weigh the risk against reward. Yet for Apple's (Nasdaq: AAPL) shareholders, it's a challenging task. To be sure, it's really hard to see how much risk there is when Apple's net cash balance stands at $137 billion -- and is on its way to $200 billion in a few years. Management has started dropping hints that shareholder-friendly moves are coming, which usually means stock buybacks or big dividend boosts.

Still, even as Apple carries relatively minor risk, it's not clear what kind of upside investors should expect either. As I noted a couple days ago, competition is gaining on Apple, which could lead to market share erosion and falling margins as price cuts ensue.

Yet there is another major consumer electronics company that also carries a fairly low level of risk, but also offers the potential of significant upside. It's a company that was the "Apple" of the industry before Apple took off like a rocket during the past decade. And it's a company that has been paying attention to Apple's success, and intends to replicate the same path.

I'm talking about Sony (NYSE: SNE), the Japanese electronics giant that had a huge run of success with products such as the Walkman, Trinitron TVs and Playstations. Yet Sony's best days are long gone. From fiscal (March) 2004 to fiscal 2012, Sony's base of sales actually shrank by more than $10 billion (to a recent $69.5 billion). And investors have fled the company's stock.

Seeds of renewal
Much of Sony's demise can be tied to the resurgent Japanese yen, which rallied sharply against the U.S. dollar and the euro during the past five years. That made Sony's cost structure, much of which is still tied to Japan, far higher than rivals that had already embraced lower-cost manufacturing sites in China, South Korea and elsewhere.

A pullback in the yen in recent months helps explain why shares have begun to rebound in recent months. The yen has been especially weak when compared to the South Korean won, which may alter the competitive balance between companies like Sony and So. Korea's Samsung (Nasdaq: SSNLF).

Citigroup's Kota Ezawa says the weaker yen "allows Sony to be less risk averse in consumer electronics, where the strong yen had forced it to abandon or downsize operations." In fact, Sony's TV and notebook PC divisions had been marginally unprofitable, but the yen's slide now makes those divisions slightly profitable, according to analysts. Ezawa adds that as profit margins tick up a bit on the weaker yen, the company will be able to generate a "wider product lineup, increased RD investment, and the potential to increase leverage."

Indeed, a recently articulated management strategy sounds like a blueprint for renewed relevance. Here are the key ingredients...

Sony hasn't been much of a player in the smartphone segment, but aims to build a more meaningful presence with its Xperia line of phones, which were launched in January. Apple and Samsung dominate the smartphone segment right now, with firms like Nokia (NYSE: NOK), Asus and others trying to solidify their role as a viable player in those ranks. "Of the second-tier players, Sony could steal the prize, thanks to its global reach, the depth and prospects of its hardware features and functions, and its lineup of smartphone-related products," suggests Citigroup's Ezawa.

Investors are also keeping an a close eye on the Feb. 20 launch of the Sony PlayStation 4 to gauge the relative pricing and performance of the new gaming console. In the past years, the release of a new console has generally provided a boost to shares of the console makers, and if Sony can capture positive initial buzz with the new PlayStation, then analysts will start to focus on sales and profit upside for the division during the next two-three years.

Though the TV business has been a clear sore spot for Sony, the pullback in the yen should eliminate the divisional bleeding as gross profit margins move back up to levels seen by Samsung and others. In the next 18-months, Sony will either bring renewed energy to this division in terms of new products and marketing efforts, or shrink it further to divert resources elsewhere. Investors would applaud either move.

Sony's film studio, Sony Pictures, is one of the few current sources of strength for the company. Fiscal third-quarter (December) sales rose 30% to $2.2 billion and generated roughly 10% operating margins. This division would likely fetch $6 to $7 billion if Sony sought to sell it, according to analysts. This would free up a lot of cash to more aggressively invest in the various consumer electronics divisions.

Meanwhile, by a pair of metrics, Sony's stock remains quite inexpensive. First, shares trade at just 0.6 times book value, while rivals Sharp (OTC: SHCAY), Kyocera (NYSE: KYO), Nintendo (OTC: NTDOY) all trade above book value. And on an enterprise-value sales basis, shares are given little credence, at least when compared to Apple.

Simply looking at past performance, Apple deserves a richer valuation. But should Apple be worth nearly 30 times more than Sony, on an enterprise value-to-sales basis? Said another way, if Apple's franchise is worth roughly $300 billion, then should Sony's franchise be worth just $12 billion?

As the recent fall in Apple's stock appears to anticipate, Apple's business model is "reverting to the mean," which is to say that forward growth rates and profit margins will likely start to drift down toward the industry average. Sony, meanwhile, is armed with considerable resources, and stands a decent chance of generating accelerating sales growth.

Risks to Consider: Sony's rebounding fortunes are tied to the yen, and if the yen rallies back to recent heights, then investors would again sour on Sony and other Japanese multinationals.

Action to Take -- None of this is to suggest that Sony and Apple are comparable companies. It's to say, however, that Sony's shares are notably less expensive, even as the company aims to rebuild its broken reputation. Though both of these stocks have fairly limited downside, a reinvigorated Sony appears to offer greater long-term upside.

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By: David Sterman