OREANDA-NEWS. Fitch Ratings says Sony Corporation's (Sony; BB-/Stable) new mid-term strategy to prioritise significant profitability improvements is credit positive because low margins are the key reason that the company is rated significantly lower than during its heyday. However, rating upgrades will depend on management's ability to successfully execute this strategy and deliver sustained profitability and free cash flow improvements.

Some benefits of restructuring are already factored into Sony's ratings, but the new strategy reveals a clearer direction and commitment from management to position return on equity as the primary key performance indicator. Struggling operations will be jettisoned to focus on operations that have stronger competitive advantages and higher profitability. Fitch has previously said that Sony's reluctance to discontinue weaker products was a credit weakness.

Sony's new strategy is more coherent as it shifts the focus from mobile phones and digital cameras to image sensors and entertainment businesses, while maintaining PlayStation as the third leg of its growth strategy.

We expect the company to maintain a market-leading position in high-end image sensors and to continue to be one of the largest global recorded music companies and among the leading movie studios. Its PlayStation 4 significantly outsold Microsoft Corporation's (AA+/Stable) Xbox One during 2014 and we think it will remain the market leader. Sony aims to generate a combined EBIT of JPY247bn from the device, game and entertainment businesses in the financial year ending 31 March 2015 (FYE15).

Struggling operations, such as TVs and mobile phones, if they remain within the group, will still have the potential to drag down overall profitability because they face intense competition from Korean and Chinese manufacturers and unfavourable exchange rate impacts. Nevertheless, Sony is separating its various electronics businesses to increase accountability and autonomy, and may consider selling or finding partners for struggling units, though management did not provide any specific timeframe for exiting the unprofitable businesses.

We believe Sony's market-leading image sensor business and on-going restructuring initiatives may help the company's credit profile improve and close the rating gap between it and Panasonic Corporation (BBB-/Positive). However upgrades for Sony will require lower leverage as well as higher margins. Both Sony and Panasonic are aiming for over 5% operating margins in the medium-term; Panasonic currently has a conservative capital structure with net cash of over JPY200bn at end-December 2014, whereas Sony had net debt of some JPY300bn, excluding Sony Financial Holdings.