Samsung Earnings: Chipsets Likely To Offset Slowing Growth In Smartphones

Samsung Electronics (PINK:SSNLF) is slated to announce its Q3 2013 results on October 25th. The South Korean giant has already given a preview of what to expect, with revenue guidance of 59 trillion Won and operating profit guidance of 10.1 trillion Won. The segment-specific guidance hasn’t been given though, and it will be interesting to see how the mobile division has performed amid slowing growth in the high-end smartphone market. Last quarter, Samsung’s mobile division – which accounts for almost two-thirds of the group income – posted low single-digit sequential growth in profits despite launching its flagship S4 during the quarter. This was, however, more than offset by rising prices of memory chipsets as well as demand for smartphone screens, which propped up profits in the semiconductor and display divisions by 64% and 46% respectively.

We expect the trend to have continued in Q3 as well, with both of the supply-side divisions benefiting from overall smartphone growth and offsetting any weakness in Samsung’s mobile division. What has also supported chipset prices in recent quarters is a supply crunch brought about by years of cautious investment and smaller players such as Micron consolidating and optimizing factory capacity for profits. A recent fire at a Chinese plant owned by SK Hynix in early September has further compressed supply, likely causing prices to shoot up at the back end of the quarter. With Hynix aiming to restore operations in November, the near-term supply crunch is likely to bolster Samsung’s results further in Q4 as well. Our $1,350 price estimate for Samsung is in line with the current market price.

See our full analysis for Samsung Electronics

Sustaining Smartphone Momentum Will Be Tough

In recent years, Samsung’s mobile division has proved invaluable in offsetting the negative business environment that its other segments have been operating in. While the semiconductor division was reeling under the impact of overcapacity and pricing declines, the economic slowdown in many parts of the world had reduced the demand for PCs and TVs, and hence display panels as well. The growing demand for mobile phones, especially smartphones, and Samsung’s increasing dominance in the market served to more than make up for the weakness coming from the TV and PC side.

However, with competition increasing at the low end of the smartphone spectrum and saturation seeping in at the high end, it will be tough for Samsung to maintain its past mobile growth. Samsung has acknowledged this much, saying that while the smartphone market would grow in the third quarter, it was likely do so at a slower pace than before. To be sure, the smartphone market is still expected to grow at a faster rate than the overall mobile phone market as smartphones cannibalize feature phone sales. However, most of that growth is going to come from the lower end in emerging markets, where profit margins are lower and being rapidly eaten into by rising competition. Apple’s decision to not launch a low-cost iPhone this year (not counting the relatively cheaper iPhone 5C) may have mitigated some of Samsung’s near-term concerns, but the iPhone maker is facing its own growth concerns and could look to aggressively market some of its relatively lower end products such as the iPhone 5C and 4S in emerging markets.

This is why the South Korean conglomerate is increasingly looking to extend market share gains at the high end by aggressively marketing the S4 in developed markets such as the U.S. Its decision to hold the S4’s launch event in New York points to this strategy (see Samsung Has Its Sights Firmly On Apple With Galaxy S4 Launch). The S4’s initial sales milestones suggested that it was selling about 70% faster that its predecessor, the S3, but that sales growth is likely to have tapered off in the following months as the initial launch euphoria died out and Apple launched its next-generation iPhone in September. With its recent Galaxy Gear smartwatch launch, Samsung is looking to widen its hardware ecosystem of companion mobile products as a means of promoting sales of its high-end S4 and Note 3. (see Samsung’s Galaxy Gear Would Broaden Its Mobile Ecosystem But Add Little Value)

Business Environment Improving On The Supply-Side

With smartphone profits peaking, it is a good sign that the overcapacity concerns in the chipset market are decreasing and prices are stabilizing after several years of contraction. As a result, operating profits in the semiconductor division last quarter grew almost 70% y-o-y and 64% sequentially. Sales of consumer electronics such as TVs in developed markets are also improving, as macroeconomic concerns arising from the Eurozone show signs of abating. The LED portion of the market is growing more rapidly than the rest, helping Samsung increase shipments of its higher-end value-added products. This has helped TV panel ASPs improve, offsetting some of the weakness being seen on the mobile panel end.

Declining demand for PCs is having an impact on the chipset division, causing PC DRAM sales to take a hit. However, the transition to mobile devices is creating a welcome shift in mix towards mobile DRAM, but the company could fall short of demand if it fails to ramp up production adequately. Samsung will therefore look to get its NAND flash fab in China up and running by early next year. The tightness in supply may however cause prices to continue to improve from current levels, limiting the near-term impact on chipset sales. Apart from memory chipsets, Samsung also builds app processors, including its Exynos line which is used in both the Galaxy S series and the Note phablets. The growing demand for smartphones and tablets should help keep sales of mobile chipsets high, and Samsung should continue to benefit from this transition so long as it meets its capacity build-up targets.

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