Sonos: Fundamentals Deteriorate

Last summer I last looked at shares of Sonos (NASDAQ:SONO) when I concluded that the sound of the message was improving. This came after the company fell victim to inflationary pressures, hurting consumer demand and the company's margins, as the company cut its guidance subsequently. With the valuation being reset quite a bit, appeal was improving, albeit for investors with a tolerance for risks.

Putting Things Into Perspective

Sonos went public at $15 per share in the summer of 2018, as I was quite skeptical on the prospects for investors at the time, fearing a similar outcome to other consumer hardware device companies like GoPro and Fitbit, which have not translated into decent long term investment opportunities.

A $1.3 billion valuation at the time was applied to a business which generated about a billion in sales on which the company posted a small operating loss of $16 million. Shares were stagnated in 2018 and 2019 as the business failed to post (meaningful) profits despite the popularity of its products.

Pre-pandemic shares still traded in the mid-teens, as shares rallied to the $40s in 2021. This came as the company only saw modest growth in sales to $1.33 billion in 2020 on which a $27 million operating loss was reported. The real operational gains were only seen in 2021 as revenues did eventually rise 29% to $1.72 billion, EBITDA was up to $279 million, and operating profits were reported at $155 million, equal to $1.13 per share.

That was encouraging as Sonos built up a net cash position of $640 million, quite sizeable, and further sales and earnings growth was seen in 2022. The company called for 2022 sales to rise by about 14% to a midpoint of just shy of $2 billion with EBITDA seen between $280 and $325 million.

With shares on their retreat in 2022, the situation slowly started to get more appealing, although shares held up far better than pure pandemic plays like Teladoc, Zoom or Peloton. These had seen bigger share price declines, albeit that their businesses were a bigger beneficiary of the pandemic as well.

By August of last year shares fell to $17, as bad news arrived. This came as third quarter results showed a small decline in sales on an annual basis, accompanied by associated margins pressure, with net cash position coming down as well. The near $2 billion revenue outlook was cut to just $1.74 billion, implying that growth essentially came to a standstill.

Moreover, full year EBITDA was set to fall from about $300 million to $222 million, a big cut on this front as well. This suggests that EBIT comes in around a hundred million, as I pegged earnings power around $0.60-$0.70 per share, far below the >$1 number seen before.

With shares down to $17, or $13.50 if we factor in net cash holdings, I pegged the forward multiple at 20 times earnings, even as those earnings were down a lot. For appeal to be seen, some execution would be required in a tougher operating environment, all while a surprised resignation of the CFO did not instill much confidence as well.

Still Going Nowhere

Since August shares have initially hovered around the $15 mark until they started a gradual but steady recovery to $22 in recent weeks, after which shares lost a quarter of their value again, now trading at $15 per share following the release of soft second quarter results.

In November, the company posted its full year results. While sales of $1.75 billion were in line with expectations, fourth quarter sales were down 12% on the year before. Following a $60 million operating loss in the fourth quarter the company saw huge margin pressure for the year as earnings of $0.49 per share fell way short compared to my expectations. Net cash fell to just $275 million amidst these losses, investments and some initial share buybacks.

For the fiscal year 2023 the company guided for sales to come in between $1.7 and $1.8 billion which is flat on a reported basis, but up 4% in constant currency terms. Margin pressure was set to persist, with adjusted EBITDA of $145-$180 million set to fall substantially from $227 million in 2022. This reveals that few realistic earnings would likely be seen in 2023. Despite lower cash holdings and the soft margin outlook, the company announced a $100 million buyback program to return cash to investors in this form.

In February the company posted relatively solid first quarter results, seasonally an important quarter for Sonos of course. First quarter sales rose a percent to $673 million, although that adjusted EBITDA margins fell 6% to 18% and change. On the back of these relatively solid results, the company maintained the guidance for the year, both in terms of sales and margin expectations.

The second quarter results were a bombshell report, with sales down 24% to $304 million. While gross margin pressure was relatively limited, very poor leverage was seen on the bottom line with an adjusted EBITDA profit of $47 million turning into a loss of nearly $11 million.

The company cut the full year sales guidance by a hundred million to $1.65 billion as a result of the softer quarter, although that the cut in the EBITDA guidance was relatively limited. After all, the midpoint of the EBITDA guidance was now cut to $153 million, down just ten million from the previous expectation.

Net cash holdings rose to $295 million following solid working capital conversion, which based on 128 million shares outstanding comes down to just over $2 per share. These shares now trade at $15, for a $1.9 billion equity valuation and $1.6 billion enterprise valuation.

And Now?

The reality is that after becoming cautiously upbeat last summer, on which I did not act upon, I am still very cautious even as shares are now down to $15 again. In the meantime, we have seen meaningful pressure on both sales and margins, as notably the margin front is utterly concerning.

After all, after backing out depreciation expenses and stock-based compensation expenses, realistic earnings are hardly to be found here. This makes me very cautious here despite the undisputed strong product and brand leaderships.

For me the current share price levels versus last summer make the situation less appealing as the fundamental performance has simply deteriorated quite a bit, making me too cautious to get involved here just yet.

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