The economic downturn has weighed heavily on the fortunes of the Consumer Electronics industry. Consumer electronics sales stagnated in 2008 and through most of 2009 as a result of the deteriorating economic conditions in the U.S. With little to no revenue growth, consumer electronics companies have been resorting to cost-cutting and share repurchases to drive bottom-line growth.
In the first half of 2009, 50% of the world’s electronic equipment makers experienced revenue declines. Inventory drawdown from last year further impacted volumes in major consumer electronics categories. The recession hit the consumer electronics industry in the back half of 2008, pulling down annual revenue numbers. The average U.S. household spent $1,229 on consumer electronics in 2008, a 12.5% decline from 2007. All consumer electronics companies witnessed significant gross margin declines, as prices went down year over year. As a result, leading hardware companies started pushing units to sustain revenue growth at the significantly lower prices.
Weak consumer spending, deferred discretionary purchases, heavy price declines, headwind from foreign currency fluctuations, cannibalization of existing markets (i.e. the shift from desktops to laptops to netbooks), a mature PC market, compositional shifts in key product categories, intense competition and a slowdown in emerging markets all contributed to the weakness in consumer electronics.
Moreover, the current year has been challenging for the video gaming industry as a combination of the maturity in the market and the recession led to continued sales declines. Lack of new game releases, intense price wars among the top gaming companies, difficult economic conditions and a huge decline in consumer spending were additional challenges. Soaring costs of video game consoles and a huge decline in hardware prices have pressured manufacturers on both sides.
Moreover, most of the hardware market is mature and is highly competitive, with a slowing growth rate. According to the research firm NPD Group, the largest decline for consumer electronics was in hardware sales, which plummeted 10% year to date.
While 2009 started with muted sales, there was a pick-up in the second half. We believe consumer confidence is on the mend. So we expect full-year 2009 revenues from consumer electronics sales to be flat year over year, with growth coming in the latter half of 2010.
The CEA-CNET Index of Consumer Technology Expectations (ICTE) reached 93.5, the highest since January 2007. The index measures consumer expectations about technology spending.
According to the CEA, spending on consumer electronics will be up 8% this year, with more than 80% consumers (the highest ever) planning to buy consumer electronics products for gifting this holiday season. The CEA predicts that $222 will be spent by the average consumer. Factory sales are estimated to be about $165 billion in 2009. Moreover, shoppers will spend a larger part of their income on consumer electronics items this year than they have in the past three years.
Moreover, the major drivers for growth in consumer electronics will be a pick-up in technology spending, increasing PC sales, higher mergers and acquisitions, higher discounts, new product releases and the entrance of Chinese players into the U.S. market.
In 2009, the most successful Chinese IPO was the online video games maker
Changyou.com Ltd (
CYOU), carved out from Chinese Internet portal
Sohu.com (
SOHU) and
Shanda Games Ltd (
GAME), a subsidiary of
Shanda Interactive Entertainment Ltd (
SNDA). We believe a shift toward online gaming, particularly the multi-player online role-playing game (MMORPG) and increased government spending will benefit Chinese online game developers.
Drivers for the Holiday Season
In our opinion, consumer electronics sales in the holiday season will be robust. Enterprise spending has rebounded modestly, although we have yet to see a significant acceleration in IT spending by large enterprise customers.
Price cuts on TVs, smartphones and games, as well as discounts at department stores, are the biggest attractions for consumers this holiday season. Consequently, we should expect to see margin pressure at both retailers and manufacturers.
The most important consumer electronics products include televisions, camcorders, DVD players/recorders, digital and still cameras, personal computers, LED and LCD TVs, games, cell phones and toys. Digital displays (comprising 15% of total industry sales) will continue to be the primary revenue driver for the industry.
It appears that the worst is over in consumer electronics, as demand for computers and flat panel display TVs is stronger than would be normal on a seasonal basis. But the worldwide recession had driven some consumer electronics companies to reduce production of components, which is now causing some shortage in the market. These include DVD and CD drives (since optical pick-up heads are in short supply), HDD drives for notebooks and LCD glass panels.
Netbooks
The strongest driver in consumer electronics this holiday season is likely to be the netbooks. According to ABI Research, 35 million netbooks will be shipped in 2009. As per the most recent data released by Gartner, PC shipments in 2009 are expected to rise 2.8%, up from the previous forecast of a 2% decline, thanks to the increased sale of inexpensive consumer notebooks and netbooks. We expect PC sales to show positive gains in the first half of 2010.
Netbooks are expected to thrive, driven by
Microsoft’s (
MSFT) new Windows OS7.
Google (
GOOG) aims to take over the consumer electronics netbook market in the latter half of 2010 with its new Chrome operating system (OS). Handset maker
Nokia (
NOK) has entered the netbook market with its Booklet 3G, a mini laptop, and has introduced new netbooks and MIDs to take advantage of the flourishing market in consumer electronics.
Moreover, both
Disney (
DIS) and Nickelodeon -- owned by
Viacom (
VIA) -- have plans to launch low-cost netbooks targeting young children, which will be a further boost to consumer electronics sales.
Apple’s (
AAPL) Macbook is also expected to remain strong.
TVs
Growth in consumer electronics is expected to be aided by strong revenue from LCD TVs. The TV market is picking up, driven by deep discounts and aggressive price cuts. Overall declines in LCD TV pricing are encouraging consumers to purchase, upgrade or replace sets. Moreover, a dip in panel prices is expected at around Christmastime due to higher inventory and de-stocking efforts and increased global demand for 40-inch and larger LCD TVs. However, falling ASPs in LCDs will hurt margins.
Demand for flat panel display TVs, particularly in HDTV, is booming. We expect Samsung’s new 46-inch LED-LCD HDTV to be quite impressive. Moreover, new deals rolled out by
Best Buy (
BBY) and
Wal-Mart (
WMT) will help expand the consumer electronics market. Wal-Mart is marketing Sharp Corporation’s 42-inch HDTV for under $500.
Video Games
The video game market is expected to benefit from the recovery in consumer electronics spending. Also, the release of a new handheld video game and price cuts on all the three major consoles, Nintendo’s Wii, Microsoft’s Xbox and
Sony’s (
SNE) PS3 are expected to boost sales.
Overall sales of consumer electronics are expected to benefit from the release of
Activision Blizzard Inc’s (
ATVI)
Call of Duty: Modern Warfare 2. The game made $550 million within its first five days of release, which is an industry record. Moreover, the strong growth is attributed to the upgrade cycle caused by the Microsoft’s xBox 360, Sony’s PlayStation3 and the Nintendo’s Wii.
DVD and Blu-ray
The next-generation DVD and Blu-ray players are poised for growth in 2009. Unit shipments of Blu-ray players are expected to jump 112% this year. Pricing on Blu-ray players have fallen an average of 35%, which will help boost volumes.
Smartphones
Smartphones are steadily growing into handheld computers. Both Microsoft and Google are making operating systems for handsets, while
Dell (
DELL) will debut its first smartphone in China. Continued innovation in the smartphone category is leading to high consumer demand and increased shipment revenues for this consumer electronics category. The cellular phone market has become stagnant except for the smarphones. Apple’s iPhone and iPhone 3GS has shown tremendous success. Moreover,
Motorola’s (
MOT) Droid and
Research in Motion’s (
RIMM) BlackBerry will drive industry growth.
The smartphone market is characterized by intense price cuts and strong competition. Such high price cuts will attract consumers and give lots of choices in the coming holiday season. Recently, both Wal-Mart stores and
Amazon.com Inc (
AMZN) have slashed the price of the new
Palm (
PALM) Pixi phone by 75% from the original $100 after the Pixi went on sale at
Sprint Nextel Corp. (
S). Moreover, in an effort to increase holiday sales,
Verizon (
VZ) cut the price of Motorola’s Droid by 25% to 40%.
E-reader
Amazon has announced the availability of Kindle e-reader for PCs, which is an emerging consumer electronics product category and is doing particularly well. The Kindle is expected to become the top selling product this Holiday season. Moreover, Kindle is benefiting from the lack of availability of competing consumer electronics products such as the Sony’s Reader and
Barnes & Noble’s (
BKS) Nook in time for Christmas. According to Forrester’s research, three million e-book readers will be sold in 2009, 30% of which will be in the holiday season. Additionally, e-book reader sales are expected to grow to six million units in 2010 and 30 million units by 2013, according to research firm in-Stat.
Other
However, certain consumer electronics categories such as digital cameras and Mp3 players have reached maturation. Growth in the digital music player market may slow down as the core market becomes saturated.
The personal navigation device (PND) market has also matured as prices declined, consolidation occurred and shipment growth slowed. While the consumer electronics PND market is losing out to the GPS-enabled mobile phone market, we believe the market for GPS has been saturated as well and will not be able to bounce back to the level it had two years back. The CEA predicted that GPS sales this year will be 20% below the year-ago level.
OPPORTUNITIES
Our top pick in the consumer electronics sector is
Apple Inc. (
AAPL). Year-to-date, Apple share prices have more than doubled. Apple’s cash flow remains strong and the company has no debt. Its Macintosh product continues to gain market share, with significant gains in portables, music players and smart phones. The company has experienced tremendous growth as both revenue and earnings exhibited strong growth. We believe the company will continue to post solid results due to the resurgence of its Mac portable systems and growth in iPhones.
We also remain positive on
Hewlett-Packard (
HPQ) and expect growth to resume in the first half of 2010. The company has a strong cash position and returned $2.3 billion to shareholders in the form of share repurchases and dividends and has projected fiscal 2010 earnings above Zacks Consensus expectations. We expect Hewlett-Packard to grow as a result of a boost in PC sales and improved IT spending.
Although we have Neutral ratings on the largest consumer electronics makers such as Sony,
Panasonic (
PC) and Sharp Corporation, we believe the major driver of growth will be the upliftment in the outlook for the LCD TV market and robust sales of advanced DVD recorders and appliances. Even though the results for 2009 have been hit hard due to a slump in consumer electronics spending, weakening of the dollar against the yen, the worldwide recession and huge price cuts that impacted margins, both Sony and Panasonic raised their full year estimates.
Meanwhile, video gaming consoles are expected to be on the top spot this holiday season due to new releases and tremendous cost cuts. We remain positive on
Take-Two Interactive (
TTWO) and
Electronic Arts (
ERTS).
We are also positive on
Amazon.com (
AMZN), as the company’s sales in the holiday season will be much stronger than we had originally expected. Amazon’s e-reader, Kindle, is doing particularly well. Although many lesser-known consumer electronics products will enter the market, we expect Kindle sales to continue growing over the next few years. The company’s international business is also very strong. This segment continued to witness double-digit year-over-year growth throughout the recession, balancing out the softness in the consumer electronics domestic business. Profits have also increased, as International is a higher-margin business.
We particularly like
Seagate (
STX) for its higher cash-flow generation abilities and its HDD business, which remains a growth driver for the industry.
Longer term, we would look for consumer electronics stocks that are rich in valuation, diversified revenue bases, have positive cash flows and have potential growth in earnings. We expect the results for most of the consumer electronics companies and retailers to improve, driven by strong holiday season sales.
WEAKNESSES
While the Consumer Electronics industry is in a state of recovery, consumers are still cautious in their spending, which we believe will take time to recover. Even though sentiment among consumers is improving, consumer electronics retailers still face a challenging environment. We recommend avoiding stocks that offer little or no growth opportunities.
We are concerned about
LG Display (
LPL) and strongly advise investors to stay away from the stock. The company has been witnessing an oversupply of TFT-LCD panels and falling ASPs are a deep concern. Moreover, the company is witnessing intense competition in the LCD business from bigger Asian companies.
We would like to avoid consumer electronics stocks such as
Palm Inc (
PALM), given the growing competition and increased pricing pressure. We believe Palm’s competitive position has been permanently damaged by its antiquated offerings, and the company is still selling only a small fraction of Pre phones to smart-phone users.
Further,
Dell Inc. (
DELL) continues to lag the PC market recovery. It faces strong consumer electronics competition from established firms such as Apple and Hewlett-Packard. Low-cost products from companies such as ASUS and Acer pose a threat to the stock. Despite cutting down prices, Dell lacks innovation and has been suffering market share losses. We believe Dell will continue to struggle due to weakness in emerging consumer electronics markets and the mobile/consumer segments of the PC market.
Finally, in the consumer electronics gaming segment we would avoid stocks like Nintendo and
Activision Blizzard (
ATVI).
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