Samsung Q2 Preview: Weaker Smartphone Sales, Inventory Concerns Will Impact Results

by Trefis Team
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Samsung Electronics (PINK:SSNLF) is expected to announce its Q2 2014 earnings at the end of July. The company has already provided a preview of its results, noting that its operating profits are expected to fall between 22.3% and 26.5% compared to the same quarter last year, while revenues could also decline by about 10%. Some factors that are likely to impact earnings include a strong Korean won, sluggish sales of smartphones and tablets, and higher marketing costs related to clearing excess smartphone inventory in markets such as China and Europe. Here is an overview of some of the trends that we believe could influence Samsung’s earnings.

See our full analysis for Samsung Electronics

Trefis has a $1,450 price estimate for Samsung Electronics, which is about in line with the current market price.

Slowing Smartphone Shipments : Samsung’s mobile phone division has proved to be its bread and butter over the last few years. The division accounts for over half the company’s revenues and about 40% of the company’s value, according to our estimates. The company rode the smartphone growth wave, owing to its wide range of handsets at multiple price points, its formidable marketing capabilities and its early entry into the large-screen smartphone or “phablet”  category. Samsung held roughly 30% of the global smartphone market as of Q1 2014, making it the largest smartphone vendor by far. However, the broader smartphone market is expected to slow down, with research firm IDC indicating that growth rates for 2014 could be less than half of the 39.2% growth seen last year, with sales growth possibly slowing down to single-digit levels by 2017. [1] Samsung in particular could feel the pinch, considering its vertically integrated model of sourcing hardware such as displays and processors from its components business.

Weak Product Differentiation High-End Smartphone Market : The high end of the smartphone market is becoming increasingly saturated, owing to the high levels of smartphone penetration in developed markets such as the United States and Europe. About 65% of mobile users in the United States owned smartphones as of Q4 2013, and top markets in Europe are also expected to have similar levels of smartphone penetration. Customers are also less likely to upgrade their handsets frequently, given that the smartphone paradigm has been largely set with innovation plateauing. Samsung’s Galaxy S and Note offerings, which we believe account for a bulk of Samsung’s smartphone profits, could be the worst affected by the slowing market, owing to their comparatively limited product differentiation in an increasingly competitive market. Additionally, Apple (NASDAQ:AAPL) is expected to launch a large screen version of its iPhone later this year. Such a launch would deprive Samsung of one of its key distinguishing characteristics and we believe that the anticipation of a larger screen iPhone itself could dampen the sales of Samsung’s phablets.

Price Competition In Low End: Samsung is also facing the heat in the low and medium end of the market, which still offers scope for reasonable volumes growth at the expense of margins. Manufacturers such as China’s Huawei and Lenovo, as well as upstarts such as Xiaomi, have introduced products with high-end specifications and low prices. Some of these companies sell their products at near break-even prices, aiming to make money by providing additional software and internet services, which is in contrast to Samsung’s hardware-oriented model. These low-priced devices have been finding favor among budget-conscious yet aspirational customers. According to Gartner, Samsung’s market share in China, which is perhaps the largest market for mid-range and low-end phones, stands at about 18%, down from a peak of 25% in 2011.

Inventory Concerns In China And Europe: Samsung indicated that its profitability for Q2 is also likely to be impacted by excess stock of some handsets, which has forced the company to boost marketing spending in order to clear inventory and make way for newer launches during Q3. In China for instance, the company has been reeling under a glut of some older 3G phones at a time when customers are holding back for the rollout of next generation 4G LTE networks. The company also noted that it was facing inventory issues in Europe, where sell-in shipments declined due to a surge in channel inventories. [2] This is a concern, since premium smartphones account for a bulk of shipments in the European market and this could potentially point to weaker than expected early sales of the company’s latest flagship handset, the Galaxy S5.

Looking For Details Of Capital Return Plans

Samsung has so far resisted distributing a large chunk of its cash holdings (which stood at around $60 billion as of Q1 2014), paying out just about 7% of its FY 2013 net income to shareholders. Samsung’s dividend yield, which is a measure of a company’s annual dividend (per share) as a percentage of its share price, stood at about 1% last year.  In contrast, Apple, which has been boosting its dividends and buybacks, had a dividend yield of about 2%. However, this may be set to change, considering Samsung’s three straight quarters of profit declines and the recent under-performance of its stock (down by 6% over the last year), which could point to the fact that Samsung may no longer be a growth stock.  This could be also evident from the company’s price to earnings ratio. Samsung’s stock trades at a trailing P/E of roughly 7x, compared to Apple, which trades at about 16x. ((Foreign Investors Put Pressure on Samsung, WSJ, July 2014)) Unlike growth companies, more mature firms do not need all their cash flows to fund future growth, allowing them to distribute more cash to shareholders. While Samsung has indicated that it would be reviewing its shareholder return policy, we expect to see additional details emerge with the company’s quarterly earnings release.

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Notes:
  1. Despite a Strong 2013, Worldwide Smartphone Growth Expected to Slow to Single Digits by 2017, According to IDC, IDC, February 2014 []
  2. Samsung Press Release, Samsung, July 2014 []
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