Forget Apple, This Rival Is a Much Better Bargain

By David Sterman,

Shutterstock photo

When assessing anystock , 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 netcash 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 bigdividend boosts.

Still, even as Apple carries relatively minor risk, it's not clear what kind ofupside investors should expect either. As I noted a couple days ago , competition is gaining on Apple, which could lead tomarket 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 whyshares 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 ) , as this New York Times articlenotes .

Citigroup's Kota Ezawa says the weaker yen "allows Sony to be lessrisk averse in consumer electronics, where the strong yen had forced it to abandon ordownsize 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 toanalysts . Ezawa adds that asprofit margins tick up a bit on the weaker yen, the companywill be able to generate a "wider product lineup, increased R&Dinvestment , and the potential to increaseleverage ."

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 andprofit upside for the division during the next two-three years.

Though the TV business has been a clear sorespot for Sony, the pullback in the yen should eliminate the divisional bleeding as gross profit margins moveback 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 alot 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 timesbook value , while rivals Sharp ( SHCAY ) , Kyocera (NYSE: KYO ) , Nintendo ( NTDOY ) all trade above book value. And on an enterprise-value salesbasis , 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'sbusiness model is "reverting to themean ," 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 thesestocks have fairly limited downside, a reinvigorated Sony appears tooffer greater long-term upside.

-- David Sterman

P.S. -- If you like Samsung or Apple, then you might be interested in following Amy Calistri, editor of our Stock of the Month newsletter. Amy's compiled an astounding 87% winning record of stock picks -- with an average annualized return of 19.4%. To find our more about her incredible performance, go here.

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.

This article appears in: Investing Basics
Referenced Stocks: NTDOY , SHCAY

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