Samsung Earnings: Smartphone Woes Overshadow Gains In Semiconductors And Consumer Electronics

Samsung Electronics (PINK:SSNLF) reported a weak set of Q2 2014 earnings on July 31, amid falling smartphone sales and a strong Korean won, which rendered the company less competitive in overseas markets. Quarterly revenues declined by around 9% year-over-year while operating profits fell by 24.5%. ^[1] Although the consumer electronics and semiconductor divisions did reasonably well, they didn’t have a very significant impact on overall results since the mobile division accounts for close to two-thirds of Samsung’s operating profit. The outlook for the second half of the year doesn’t look particularly upbeat either, with margins likely to come under further pressure with the proliferation of low-priced Chinese handsets, while high-end market share could be threatened by the impending launch of Apple’s refreshed iPhone lineup. In this note, we take a look at some of the key trends driving Samsung’s results.

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Trefis will be revisiting its $1,450 price estimate for Samsung Electronics to account for the earnings release.

Smartphone Volumes Shrink, New High-End Products Lined Up

Samsung’s mobile device sales declined by about 20% year-over-year,while operating profits fell by about 30% due to lower shipments of smartphones and tablets and the excess stock of some handsets, which forced the company to boost marketing spending in order to clear inventory. Although Samsung doesn’t break out smartphone shipments, preliminary data from IDC indicates that its shipments fell by around 4% year-over-year. The declining sales come despite that fact that the global smartphone market grew by a healthy 23.1% year-over-year during Q2, with a record 295 million units shipped. ^[2] This has translated to a 7% year-over-year decline in Samsung’s market share.

Much of the volumes growth in the smartphone industry has been coming from phones at low and mid-tier price points. Manufacturers such as China’s Huawei and Lenovo, as well as upstarts such as Xiaomi, have been eating into Samsung’s market share in the sub-$200 segment by offering products with high-end specifications and low prices. It now seems inevitable that Samsung will see its margins squeezed further, since it would have to beef up specifications or trim prices to remain competitive. The going could be tough in the high end of the market as well. While the Galaxy S5 is reported to have met with just a lukewarm response in the markets, it also carries a higher bill of materials (and likely lower margins) compared to previous Samsung flagships. Additionally, the company could face more intense competition from Apple, which 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 could erode the company’s market share and pricing power in the high end as well. However, the company has indicated that it would be launching two new high-end smartphone within the next six months – one with a large screen form factor (ostensibly the Galaxy Note 4), and another model which would be built using newer materials. ^[3]

Memory Business Does Well, Near Term Outlook Positive

Samsung’s semiconductor division saw revenues rise by around 13% year-over-year, driven by stronger memory sales, although operating margins dipped from around 20% to about 19% due to a slowdown in the System LSI business. Samsung’s NAND memory business grew on the back of demand for high-density memory cards and SSDs for servers. The NAND market is expected to transition from a period of oversupply during the first half to a more balanced supply in the second half, owing to stronger demand from OEM customers, which could bode well for Samsung in the near term. ^[4] Samsung’s DRAM business benefited from increasing demand for PCs, servers, graphics, and mobile devices, while supply growth remained limited.

The DRAM market is largely cyclical, and the industry is currently transitioning out of a phase of undersupply caused by years of cautious investment. PC DRAM prices could increase in Q3, as major suppliers have been transitioning their capacity from PC DRAM to Mobile DRAM, leading to tighter supply. ^[5] Mobile DRAM prices are also expected to stabilize on the back of higher demand from device manufacturers. ^[6] Additionally, Samsung’s semiconductor margins could benefit as it manufactures more 20 nm-class DRAM chips. These chips offer differentiation in the market (about 25% lower power consumption compared to 25 nm DRAM chips), while still being more production-efficient. ^[7]

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1. Earnings Release Presentation Q2 2014, Samsung Electronics, July 2014 [↩]
2. Chinese Vendors Outpace the Market as Smartphone Shipments Grow 23.1% Year over Year in the Second Quarter, According to IDC, IDC, July 2014 [↩]
3. Samsung to launch new smartphones as profit falls, MarketWatch, July 2014 [↩]
4. Expect Tight Supply for Commodity DRAM, EPS, July 2014 [↩]
5. TrendForce: Q3 DRAM Contract Prices to Show 5-10% Growth with Decline in PC DRAM Supplies, DRAM Exchange, June 2014 [↩]
6. TrendForce: Mobile DRAM Prices Stabilize due to Tight DRAM Supply in Q3, Trendforce, July 2014 [↩]
7. Downward Trend in DRAM Prices Likely to Continue in Q1, BusinessKorea, March 12th, 2014 [↩]