Samsung Electronics (PINK:SSNLF) announced a solid set of Q3 2013 results on Friday, as revenues grew by 13% and operating profits by a faster 26% over the same period last year. The strong performance came about despite slowing growth in Samsung’s most important mobile division, which grew sequentially in the low single digits and year-on-year by 25%, as opposed to the greater than 40% growth rates seen so far this year. Part of the reason for the slow growth was weakening demand for the Galaxy S4, which was coming off a strong launch quarter, and normal seasonality going into the holiday season. However, a sustained recovery in chipset prices helped offset some of the weakness in mobile, as Samsung’s chip sales increased 12% y-o-y and improved the division’s operating margins by more than 9 percentage points.
We expect the trend to continue in Q4 as well, with chipset ASPs continuing to benefit from the ongoing supply crunch brought about by years of cautious investment and consolidation. Smaller players such as Micron (NASDAQ:MU) have been active in buying out distressed rivals 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. Taking into account the company’s increased cash balance, we have slightly revised our price estimate for Samsung to $1420, which is about in line with the market price. The company made no announcement on potential buybacks or dividends, but we expect it to shed some light on how it plans to deploy the cash effectively on November 6, when it will hold its first analyst day in eight years.
Slowing Smartphone Momentum
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 reeled under the impact of overcapacity and pricing declines, the economic slowdown in many parts of the world 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 benefit from seasonality in the fourth quarter, competition is likely to intensify further. 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 enter the sub-$400 smartphone market this year 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 than its predecessor, the S3, but that sales growth seems 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). Sales of the newly launched Note 3 sales are likely to be key to Samsung’s performance in Q4.
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. In the first three quarters this year, the semiconductor division has seen its operating profits increase by almost 78% over the same period last year. The transition to mobile devices has created a welcome shift in mix towards mobile DRAM, thereby limiting the impact from the declining demand for PCs. However, the company could fall short of demand if it fails to ramp up production adequately. Samsung is therefore look to get its NAND flash fab in China up and running by early next year. The tightness in supply may, however, allow 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, allowing Samsung to benefit from this transition so long as it meets its capacity build-up targets.
Sales of consumer electronics, such as TVs, in developed markets are showing signs of improvement with decreasing macroeconomic uncertainty, but high inventory levels continue to pressure pricing. Samsung is looking to tackle the weak TV market with greater focus on large-sized models and higher-value premium products. The LED portion of the market is growing more rapidly than the rest, helping Samsung increase shipments of its high-end products. As a result, its sales of 60+ inch TVs increased in mix from 12% in 14% sequentially. Samsung’s display unit has finished building a new LCD plant in China, which it plans to put to use in making 48- and 55-inch large screens for TVs, with value-added features such as ultra high-definition resolution.