Samsung Could Refocus Growth Strategy As Q3 Earnings Plummet

Samsung Electronics (PINK:SSNLF) posted its smallest quarterly profit in over two years, as its bread-and-butter smartphone business faces its biggest test yet, challenged  by the arrival of Apple’s much awaited large-screen iPhones and increasing competition from well-received budget offerings from Chinese manufacturers such as Xiaomi and Lenovo. The company’s other business divisions had a decidedly mixed quarter. The semiconductor operations did well, aided by strong DRAM and NAND memory shipments, while the consumer electronics division was weighed down by seasonally lower sales for appliances and lower pricing for televisions.  While the company’s quarterly revenues fell by around 20% year-over-year to $45 billion, net income declined by around 49% to $4 billion.((Earnings Release Q3 2014, Samsung, October 2014)) Samsung’s cash balance rose to a record high of around $64 billion during the quarter, but we think that it is unlikely that the company will increase its dividends or initiate share buybacks, given its ambitious semiconductor investment plans and its declining smartphone business. Here is a brief look at some of the key trends from the company’s earnings release.

Trefis has a $1,160 price estimate for Samsung, which is about 15% ahead of the current market price. We will be updating our valuation model and price estimate for Samsung to account for the earnings release.

See Our Complete Analysis For Samsung Here

Smartphone Business Declines Weigh On Results

Although Samsung’s smartphone shipments rose by around 3 million units sequentially to about 78 million units during Q3 2014, revenues for the mobile division fell by around 15% to $22.3 billion, impacted by lower average selling prices and a smaller sales mix of high-end devices. ^[1] The company’s IT and Mobile division’s profit margins (which are primarily driven by smartphones) also fell sharply to about 7% from around 15% during the previous quarter, owing to lower pricing and higher marketing and promotional costs. There were a few bright spots in the company’s IT and mobile device segment, though, as networking products sales saw growth on the back of increasing LTE-focused investments by mobile carriers. Tablet shipments also grew, aided by the launch of the new Tab S product line.

While the company admits that the outlook for its smartphone business remains uncertain, it says that it is launching a series of new mid-range and low-end devices and aims to maintain its mobile operating margins at double-digit levels. ^[2] However, we remain doubtful about the company’s ability to recapture significant momentum in the budget market, given that Chinese players such as Xiaomi and Lenovo have been increasing their dominance in the sub-$300 segment by offering products with high-end specifications at value prices. As of Q3, Xiaomi’s smartphone market share more than doubled year-on-year to over 5%, while Samsung saw its market share fall from over 32% to around 24%.((ref:2)) We think that Samsung might be reluctant follow the high-spec/low-price strategy, given that it could endanger sales of the company’s more profitable high-end models. Xiaomi, for instance, is reported to initially price products at close to break-even levels, aiming to eventually make money as component prices fall and by providing additional software and internet services, which is in contrast to Samsung’s hardware-oriented model.

Semiconductors, Components Could Drive Future Growth

The company’s memory division did well this quarter, with sales rising 15% sequentially, driven by higher shipments of mobile DRAM and strong demand for NAND memory in mobile storage and high-density PC and enterprise SSD products. Semiconductor margins also saw a bump, rising to around 22% from around 19% during the previous quarter, driven by process improvements and new technologies. The outlook for the division also remains strong, with the supply-demand balance in the memory markets expected to hold up and sales of new mobile processors manufactured using the 20-nanometer process poised to increase.

The smartphone business, which has been Samsung’s biggest cash cow in recent years, now accounts for just 43% of operating profits compared to about 65% of profits a year ago, while the device solutions business (which manufacturers semiconductor products and displays) now accounts for about 57% of total operating profits, up from about 30% in the year ago quarter. We believe that Samsung could be refocusing its growth strategy towards semiconductors and components, which are areas where it has competitive advantages owing to its technology and scale. Earlier this month, the company said that it would make its largest ever initial investment in a semiconductor facility, lining up about $14.5 billion to build chip manufacturing facilities in the Gyeonggi province in South Korea.

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. Worldwide Smartphone Shipments Increase 25.2% in the Third Quarter with Heightened Competition and Growth Beyond Samsung and Apple, Says IDC, IDC [↩]
2. Samsung profit falls to more than 3-year lows, CNBC, October 2014 [↩]