Samsung Seeks Growth From Component Business

July 28, 2013, 6:28 a.m. ET

Samsung Seeks Growth From Component Business

South Korean Company Says Pace of Smartphone Growth May Slow in Third Quarter

MIN-JEONG LEE

SEOUL—Samsung Electronics Co.’s 005930.SE -1.15% estimated spending of nearly $12 billion to upgrade and invest in its chip facilities this year underscores the South Korean company’s reliance on its component business to drive earnings at a time when smartphone profits appear to be hitting a plateau. According to IDC, Samsung sold about 72.4 million smartphones in the second quarter. The WSJ’s Min-Jeong Lee tells Yun-Hee Kim how Samsung is positioning itself to compete in the smartphone market. While the South Korean companyreported a 50% increase in second quarter net profit Friday to a record 7.77 trillion won ($7 billion), margins from its smartphone business—its biggest profit generator for the past year—were squeezed due to hefty marketing expenses tied to its flagship Galaxy S4 smartphone.“The smartphone market will likely continue to grow in the third quarter, but there’s a chance that the pace of growth may slow as competition intensifies with new model releases,” Kim Hyun-joon, vice president of the mobile business, said during an earnings call.

Samsung also warned that its average selling prices for smartphones may edge down in the third quarter as the portion of mid- to low-end phones grow within its portfolio.

In addition to mobile phones, Samsung, South Korea’s biggest company by market capitalization, is the world’s biggest supplier of memory chips, displays and televisions by revenue.

Analysts increasingly expect the company’s future growth to come from its component business, which is experiencing a rebound in profitability due mainly to strong memory-chip prices.

Samsung’s chip division, which accounted for 18% of total operating profit in the quarter, saw its second quarter operating profit increase by 71% from a year earlier.

Meanwhile, the mobile communications business—which includes handsets and telecom equipment—accounted for 66% of total operating profit. The unit’s operating profit rose 52% from a year earlier, but slowed from the 54% growth seen in the first quarter.

“Memory (chips) is undergoing structural changes that is leading to limited supply and stronger pricing and thus improved profits,” said Mark Newman, an analyst at Sanford C. Bernstein, who noted that operating profit margin for Samsung’s semiconductor business will rise to 25.2% in the third quarter and 27.8% in the fourth quarter from 20.3% in the second quarter.

Samsung’s mobile-business margin fell to 17.7% in the second quarter from 19.8% in the first quarter.

Robert Yi, head of Samsung’s investor relations, said on a conference call that in the future, Samsung will be putting more efforts to seek a “more balanced profit portfolio among its business divisions.”

Samsung’s spending of 13 trillion won on chips is similar to Intel Corp.’sINTC +0.87% planned capital expenditure of about $11 billion on factories and manufacturing equipment this year. For all of 2013, Samsung said its capital spending budget would increase 5% to 24 trillion won from 22.8 trillion won in 2012. This includes plans to invest 6.5 trillion won on its displays business.

Samsung’s net profit of 7.77 trillion won in the second quarter compares with the previous record of 7.15 trillion won in the first quarter. Operating profit for the three months ended June 30 rose 48% to 9.53 trillion won. Sales rose 21% from a year earlier to 57.5 trillion won, coming in line with the company’s guidance of 56 trillion won to 58 trillion won.

Samsung has been suffering from steep share price declines in recent months, hit by concerns over weaker-than-expected sales of its Galaxy S4 flagship smartphone. The company has been spending billions of dollars to market the smartphone both at home and abroad following a lavish launch event at New York City’s Radio City Music Hall in late March. Samsung also purchased 1 million copies of Jay-Z’s new album, “Magna Carta Holy Grail”, and gave them to Galaxy smartphone users free—72 hours before the release.

Since late April, when Samsung began selling the flagship smartphone, its shares have fallen 12.8%, wiping about $25 billion off the company’s market value. In June, brokerages started slashing their earnings and smartphone sales targets, citing lackluster demand. In Friday trade in Seoul, Samsung shares fell another 0.9% to close at 1,303,000 won ($1,170). The company didn’t disclose smartphone shipments but research firm IDC said Samsung sold 72.4 million units, giving it a dominant market share of 30.4% globally.

Samsung’s record earnings come on the heels of Apple Inc.’s AAPL +0.57% tepid earnings results. Though Apple reported better-than-expected iPhone shipments during its fiscal third quarter, the company’s net profit decline of 22% from a year earlier highlights the slowdown many of the world’s high-end smartphone makers are facing.

Demand for expensive phones is waning as cheaper Android devices from China and elsewhere flood the market. As a result, Samsung, Nokia Corp. and HTC Corp. are launching more affordable devices to diversify their product lineups, but the move could hit their profit margins in the longer term, analysts say.

“Entering into a typically strong season for the IT industry, we expect earnings to continue to increase,” Mr. Yi said. “However, we cannot overlook delayed economic recovery in Europe and risks from increased competition for smartphones and other set products.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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