Sony Ratings Affirmed by S&P

But the ratings agency says the outlook for the electronics giant is negative, citing slumping demand and severe pricing pressures

Standard & Poor's today affirmed its single-'A'-plus long-term and 'A-1' short-term ratings on Sony Corp. The outlook on the long-term rating remains negative.

The ratings on Sony reflect the company's strong position in the consumer electronics and home video game markets, as well as its conservative financial profile. The ratings also take into account pressure on Sony's profitability caused by intense competition in the consumer electronics market and declining demand in the electronic components and devices business. In addition, the ratings reflect earnings volatility in Sony's other operations, such as video games, motion pictures, and music.

Sony has maintained a fairly strong position in the consumer electronics market, underpinned by excellent brand recognition and strengths in music and film content, which add value to its software products. Despite the current adverse business environment, Sony's brand-name audiovisual products still generate solid profits. Moreover, the home video game segment returned to profitability in the first half of fiscal 2001 (year ending March 2002) after posting a ¥51 billion loss in fiscal 2000. This recovery was driven by robust sales of PlayStation2--which exceeded those of PlayStation--as well as Sony's successful reduction of production costs of semiconductors used in the PlayStation2 module.

Overall, however, the profitability of Sony's consumer electronics segment has decreased over the past few years. In the first half of fiscal 2001 (ended Sept. 30, 2001) profits from nonbrand, generic consumer electronics products, showed a particular deterioration. These include devices, mobile phone handsets, and original equipment manufacture products such as computer displays. After posting a ¥45 billion half-year loss in the mobile phone business, Sony drastically reduced its inventory and shifted its mobile phone operations to a joint venture with Ericsson (Telefonaktiebolaget L.M.). The joint venture company, Sony Ericsson Mobile Communications Japan Inc., commenced operations in October 2001. However it will not be easy for Sony to restore profitability in the mobile phone business amid weakening demand and severe competition.

Sony has already devised a clear strategy for boosting its performance in the network and digital consumer electronics businesses, which it expects to be a major source of profits within its consumer electronics segment. However, given that it will take at least a few years for these businesses to boost the overall profitability of the consumer electronics segment, Sony could face the need to consider further restructuring and cost-cutting measures. Currently, the company is also restructuring its music and motion picture businesses, which are characterized by volatile earnings, particularly the music business. Sony's efforts to cut costs in these businesses should gradually lead to an improvement in its profitability.

In fiscal 2001, Sony will incur ¥50 billion in restructuring losses, stemming from measures such as the termination of 48 unprofitable product lines. However, even taking into account the difficult operating environment, the company could still meet its revised earnings projections for the current fiscal year, given its solid profits from brand-name audiovisual products, its recovering earnings from home video games, and its restructuring efforts in unprofitable nonbrand products.

Although Sony's earnings generation has weakened, as illustrated by its results for the first half of fiscal 2001, the company's key credit measures remain moderate, with total debt to capital at 44.2% and equity to total assets at 27.4% as of September 2001. The ratio of funds from operations to capital expenditures fell to 57.5% during the first half of fiscal 2001 from 136.7% in the same period a year earlier. However, Sony's cash flow protection measures are expected to recover to a moderate level in the next year or so, given the recovery in the company's profitability and reduced capital expenditures over the next few years. Sony's management has expressed its strong commitment to preventing any further decline in the company's financial profile. Given the company's conservative financial policy, as well as the improvement in its earnings prospects that should result from its restructuring efforts, its financial profile is expected to recover to some extent over the short term.

Sony is expected to face continued pressure on earnings amid a global downturn in demand and severe pricing pressures in the consumer electronics market. The company's profitability is expected to recover to some extent in the second half of fiscal 2001. However, amid the uncertain business environment, there is still a possibility that Sony's ability to service its debt and invest in its operations could be damaged, leading to a further weakening in the company's credit standing.

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