Samsung Q2 Review: The Smartphone Turnaround Isn’t Going As Planned

SSNLF: Samsung Electronics logo
SSNLF
Samsung Electronics

Samsung Electronics (PINK:SSNLF) posted a tough set of Q2 2015 numbers, providing the clearest sign yet that its smartphone turnaround isn’t going as planned. Segment revenue fell 8.5% y-o-y as its crucial flagship Galaxy S6 handsets faced sluggish sales and production constraints. However, the semiconductor division fared better -15% y-o-y revenue growth, 82% operating profit growth – benefiting from the mobile unit’s switch to in-house app processors for high-end devices and stronger memory sales. The earnings were roughly in line with the guidance provided earlier this month, with net profits falling 8% y-o-y to 5.75 trillion won ($4.93 billion) and revenues declining 7% to 48.5 trillion won ($41.7 billion). [1] The company’s near-term outlook remains nebulous, given the increased competition from Apple’s (NASDAQ:AAPL) upcoming new iPhones (due September), FX headwinds in Europe and emerging markets, and a possibility that the current smartphone woes could spill over to the components business. In this note, we review the performance of the smartphone division and examine the company’s options in an increasingly competitive smartphone market.

See our full analysis for Samsung Electronics

Trefis has a $1,335 price estimate for Samsung, which is about 25% ahead of the current market price. We will be updating our valuation model and price estimate to account for the earnings release.

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Slow S6 Sales, Higher Promotional Costs Hurt Mobile Results

Samsung’s mobile division saw revenues decline by about 8.5% year-over-year to 26.06 trillion won ($22.3 billion), while operating profits fell by about 37% to 2.76 trillion won ($2.36 billion). Although Samsung doesn’t provide shipments data, IDC estimates that the company’s shipments slipped 2.3% y-o-y to 73.2 million units, while its market share contracted by about 3% to 21.7% in Q2. [2] Samsung doesn’t seem to have been able to cash in on the launch momentum for the S6 and S6 Edge, which went on sale early April. The company underestimated demand for the more niche S6 Edge model, as it grappled with production constraints for the dual-curved screens, while the classic S6, which was expected to bring in the volumes, has apparently struggled to compete with Apple’s large-screen iPhones. Samsung also witnessed higher marketing and promotional costs, relating to the campaign spend around the S6, and this is partly responsible for operating margins falling to to 10.5% from 15.5% in Q2 2014 and roughly 11% in Q1, despite the higher ASPs and favorable sales mix.

China is also proving a challenge for Samsung, as customers have been favoring Apple’s large-screen iPhones over Samsung’s S series of devices, while lower-end models face intense competition from local vendors such as the Xiaomi and Huawei Technologies, who specialize in cheap yet feature-rich devices. As of Q1 2015 (the most recent data available for IDC), 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.

New Devices Coming, But iPhone Refresh Could Hit Sales

Samsung’s options to profitably shore up smartphone sales remain increasingly limited, in our view. The company is planning to add more middle- and low-end models to its portfolio as it looks to regain momentum in emerging markets. Samsung is also gearing up to release its new Note 5 device and a rumored large-screen version of the S6 Edge this August. However, competition in the top end of the smartphone market is only expected to heat up in the coming months, with Apple prepping to launch the next iteration of the iPhone as early as September. Apple is reportedly very bullish on its upcoming device, planning an initial production run that is roughly 15% higher than for the iPhone 6. ((Apple’s Early iPhone Call, WSJ, July, 2015))

Trading Off Margins For Volumes With Price Cuts

Samsung’s bigger problem lies in weak product differentiation. The company operates in a crowded Android smartphone market (Android has 80%+ OS share), where vendors compete primarily based on specifications and price, with software and design based differences remaining rather limited. Samsung’s recent attempts at creating design differentiation with features such as curved screens and metal bodies don’t seem to be resonating with mainstream customers, and its pricing power remains weak. The company noted that it could cut prices of the two S6 devices, and this indicates that it is willing to trade off ASPs and margins in favor of volumes, on the lines of value vendors such as Xiaomi. Samsung’s scale and vertically integrated hardware model – which sources most electronic components from within the company – should afford it some flexibility in managing margins, as it cuts prices on devices. However, the company’s higher marketing and distribution costs could be problematic. Most value vendors keep costs low by selling online and by eschewing conventional advertising in favor of surprisingly effective flash sales and social media marketing.

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Notes:
  1. Samsung Q2 2015 Earnings Presentation []
  2. Worldwide Smartphone Market Posts 11.6% Year-Over-Year Growth in Q2 2015, the Second Highest Shipment Total for a Single Quarter, According to IDC, July 2015 []