Samsung’s Weak Q2 Guidance Increases Uncertainty Around Its Smartphone Revival

SSNLF: Samsung Electronics logo
SSNLF
Samsung Electronics

Samsung Electronics (PINK:SSNLF) published its Q2 2015 guidance figures, indicating that its operating profit is expected to decline by 4.2% year-over-year to about 6.9 trillion won ($6.1 billion), while revenues are expected to fall by about 8% to 48 trillion won ($42 billion). [1]  Although the declines have moderated considerably since Q1, when it saw a 30% y-o-y drop in profit, the guidance is still likely to worry investors, as this is the first quarter since the launch of the new flagship Galaxy S6 handsets that Samsung is banking on to bolster its smartphone unit. Samsung didn’t break out segment earnings or provide additional color on the numbers, but we think that there are likely a few potential reasons for the continued decline: 1) Weaker than expected uptake of the base S6 model; 2) Manufacturing constraints for the dual-curved screen Galaxy S6 Edge; 3) Weaker demand from China and currency headwinds in Europe; and 4) Higher marketing costs and bill of materials.

Trefis has a $1334 price estimate for Samsung, which represents a 20% upside to the current market price. We will be revisiting our price estimate after the company publishes earnings later this month.

See our full analysis for Samsung Electronics

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Slower Uptake of Standard S6 Model 

The Galaxy S6 and S6 Edge were released to critical acclaim in April, and early interest in the devices appeared to be strong. Research firm Counterpoint estimated that Samsung shipped 6 million units as of the end of April, less than a month after the launch. The sales were better than the Galaxy S5 in the same period in 2014 and made the S6 the world’s second best-selling smartphone, behind Apple’s iPhone 6 series. However, sales are likely to have moderated following the initial launch euphoria, particularly for the base S6 model, given the strong momentum that Apple has been seeing in the large-screen smartphone space. Apple lacked a large-screen offering during the same period last year.

Poor Demand Planning, Supply Constraints For The S6 Edge

Samsung has been facing production constraints for the higher-margin S6 Edge model. Although the S6 Edge is similar to the base S6 in terms of features, its premium design and novel dual curved screen have made it popular with high-end smartphone buyers. Samsung had to open a new manufacturing facility for curved OLED screens about two months ahead of schedule in order to increase S6 Edge production, according to Bloomberg, and it’s possible that it could take a few more months to fully meet demand. This could prove somewhat futile, given that competition in the top end of the smartphone market is only expected to intensify, with Apple prepping to launch the next iteration of the iPhone as early as September.

Currency Headwinds In E.U., Lack Of Momentum In China 

Europe, which is one of Samsung’s most profitable markets, has been seeing a weakening economy, which is likely to have hurt demand. Additionally, the Euro has significantly weakened against the Won this year, and this could have impacted Samsung’s revenues and margins from the region. Separately, Samsung’s woes in China’s massive smartphone market are likely to have continued. The company has lost its grip on the Chinese market amid mounting competition from Apple (which topped the market during Q1) and low-cost local vendors such as Xiaomi and Huawei. As of Q1 2015, Samsung’s smartphone shipments to China declined by more than 50% year-over-year and the company fell from 1st place to 4th place in terms of market share. [2]

Higher Marketing Spend, Higher Bill Of Materials For S6

Samsung usually conducts a marketing blitz to promote its new flagship handsets, and the campaign spend around the S6 is likely to have been larger than usual, since the company was looking to reinvigorate the image of the Samsung brand. This is likely to have increased SG&A expenses for this quarter. Further, Samsung could be seeing higher manufacturing costs for the new handsets. According IHS, the Galaxy S6 Edge is the company’s most costly phone yet to build and assemble. The 64 gigabyte model built for Verizon Wireless costs about $290 to build, including both parts and assembly. That’s about $34 higher compared to last year’s flagship Galaxy S5 and about $50 more than the 64GB iPhone 6 Plus. While these costs could decline going forward, as production ramps up and yield rates improve, it’s likely to have limited the margin upside from the S6 during Q2.

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Notes:
  1. Samsung Press Release []
  2. China’s Smartphone Market Contracts Year Over Year for the First Time in Six Years, According to IDC, IDC, May 2015 []