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Earnings Collapse Looming For Sony

Tina Wang, 01.13.09, 03:52 AM EST

Trifecta of a demand slump, strong yen and fierce competition makes it likely that Sony will post its first-ever yearly operating loss.

The global recession is tarnishing the crown jewels of corporate Japan. Following on Toyota's heels, Sony is likely on track to post its first full-year operating loss in its history.

Already, the company has damaged its standing with investors by having failed to deliver on earnings promises for seven of the past eight years. Compounding the problem of collapsed electronics demand is the competitive environment: better-positioned, cash-rich rivals like Samsung are prepared to run Sony off the rails.

Sony (nyse: SNE - news - people ) is likely to post an operating loss of 100 billion yen to 200 billion yen ($1.1 billion to $2.2 billion) for the fiscal year ending March, the Nikkei reported Tuesday. That would be the company's first operating loss since it went public in 1958. It last posted a loss in 1995, on a one-time charge. The news report sent Japanese electronics stocks sliding, with Sony shares plunging more than 8%.

A full-year operating loss would mean that Sony lost its way during the typically buoyant holiday season since it had posted a first-half operating profit. If the dismal second-half performance continues into the fiscal year ending March 2010, Sony is looking at an operating loss next year of 450 billion yen ($5.0 billion), estimates Tokyo-based CLSA analyst Atul Goyal.

Hope for a second-quarter recovery in 2009 in the tech sector will be "met with disappointment," according to a Jan. 7 report by Bank of America Merrill Lynch. Still, the industry slump is only half the picture. Whether Sony's management is well equipped to face the global recession is open to question. Though the severity of last year's second-half downturn caught many by surprise, Sony's dismal history of failing to deliver on its promises signals a management problem.

"Seven out of eight years, Sony has failed to meet its own initial operating profit forecast. This is probably the worst track record amongst most major exporters," Goyal said. "That means that either management is not able to anticipate challenges … or they fail on execution almost every time. Either way, it does not reflect well on Sony's management." In October, Sony forecast a full-year operating profit of 200 billion yen ($2.2 billion). During the eight prior years, Sony missed its targets by an average of 40.0% to 50.0%.

The company is further handicapped by the yen's recent surge. Sony's likely operating loss is based on the yen's average of more than 100 to the dollar and 151 against the euro this past year. But if the yen continues to hover around 90 to the dollar and 120 to the euro, Sony faces additional losses of about 275 billion yen ($3.1 billion) next year. Each strengthening of 1 yen against the dollar costs Sony 4 billion yen ($44.7 million) in operating profit, and each time the currency strengthens by another yen unit versus the euro, the firm forgoes another 7.5 billion yen ($83.9 million), according to Goyal.

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Sony's rivals are all in the same boat, facing collapsed demand in memory chips and liquid crystal displays. Toshiba (other-otc: TOSBF - news - people ) will post its first operating loss in seven years, of up to 200 billion yen ($2.2 billion), according the Nikkei. But Sony is debt laden and losing market share to better-capitalized competitors in nearly all of its core electronics businesses: Samsung (other-otc: SSNLF - news - people ) in televisions, Canon (nyse: CAJ - news - people ) in cameras, Nintendo (other-otc: NTDOY - news - people ) in gaming, Apple (nasdaq: AAPL - news - people ) and Hewlett-Packard (nyse: HPQ - news - people ) in laptops. Meanwhile, Korean tech companies have a currency advantage because the won's slide has boosted overseas earnings and made Korean goods relatively cheaper abroad.

Finally, though Sony said it is slashing jobs and capital spending to save 100 billion yen a year, the associated restructuring charges, particularly in light of Japan's culture of high severance payments, will offset the cost saving next year.

In Tokyo trading Tuesday, Sony shares slid by 195 yen ($2.18), or 8.9%, to 2,000 yen ($22.38). Toshiba shares shed 36 yen (40 cents), or 8.6%, to 385 yen ($4.31). Sharp (other-otc: SHCAY - news - people ) shares tumbled by 76 yen (85 cents), or 9.2%, to 751 yen ($8.40). Canon shares faded by 225 yen ($2.52), or 7.2%, to 2,905 yen ($32.51). Panasonic (nyse: PC - news - people ) shares retreated by 94 yen ($1.05), or 7.8%, to 1,110 yen ($12.42).