- Samsung Q4 2015 earnings missed analyst estimates. However, the company seems better positioned to grow sales despite the downbeat commentary on guidance.
- I anticipate revenue growth of 5% for FY'16 and net profit margins remaining flat.
- I anticipate 18.58% upside to the stock in FY'16. My stance diverges considerably from the analyst consensus, as I anticipate the valuation to recover towards the back half of the year.
Samsung Electronics (OTC:SSNLF) reported a fairly weak quarter in terms of profitability despite being near the consensus range in terms of revenue. The company reported revenue of 53.3 trillion Won, which fell slightly below consensus estimates of 53.5 trillion Won. The slight miss on revenue wasn’t the problem as profitability declined from 5.35 trillion Won to 3.22 trillion Won year-over-year in Q4’ FY15. The consensus anticipated net income of 5.4 trillion Won, and it was not broadly anticipated that non-operating items would swing the P&L so significantly in Q4’15.
The earnings decline primarily came from the component business according to the earnings conference call. The Korean Won strengthened during Q4, which translated into approximately 400 billion Won in negative impact to operating profit in the component business. The company also reported mark-to-market losses in some of its subsidiary businesses, which netted out into a 1.41 trillion Won loss, which offset equity/finance gains. All in all, when excluding that impact, the profitability was similar to the prior-year period, but the stock declined following the earnings announcement due to the uncertainty in mobile/component guidance.
The memory business will likely decline sequentially due to seasonality. The company didn’t provide a whole lot of guidance on the memory business, but when compared to semiconductor peers, I do anticipate Samsung to retain its competitive market share due to pricing/performance dynamics. The company will continue to ramp up the 3rd generation V-NAND in the first quarter, which is the lone bright spot in the company’s reporting segments as it grew by 17% year-over-year in FY’15. Of course, the competitive dynamics are hard to follow, but competition in the 3D NAND/V-NAND space is expected to increase due to Intel’s ramp-up of 16nm memory components within the enterprise. Micron is also making progress in the consumer segment with lower cost components with lower read/write speeds. It’s not yet clear whether the market will shift away from Samsung components, as the company tends to compete more aggressively to gain OEM share, as it tends to operate at greater economies of scale with less emphasis on margins.
Furthermore, the LSI segment where they focus on SoC packaging, third-party fabrication, display driver integrated circuits, NFCs and CMOS image sensors among many other things should exhibit some growth when based on Credit Suisse’s mid-single digit growth forecast for mobile devices in general. The company’s app processor line-up has strengthened, so there’s potential to gain market share from some of its chip rivals, but it’s not yet clear whether Samsung will pivot its high-end Exynos SoCs away from just Samsung handsets as an off the shelf product for third-party OEMs.
I am plenty aware that Samsung is competing for handset silicon similar to Qualcomm with end-to-end solutions in the low-end, which faces some competition from Huawei and Intel among others. The dynamics of this market are somewhat hard to follow,, even though the Street broadly anticipates that Samsung will differentiate its high-end handsets with Exynos 8890 and Snapdragon 820 variants. It’s worth noting that Samsung has closed the performance differential quite considerably, which creates a more challenging environment for mobile semiconductors attempting to compete with Samsung.
Given the fact that Samsung’s cash generation will likely remain stable, it’s anticipated that Samsung will continue to ramp up its CAPEX, which is reflected in Samsung PP&E spending within the cash flow statement. The company didn’t provide guidance on its CAPEX, but reiterated that it was in a heavy investment phase due to 16nm build out. I anticipate that Samsung’s fab technology will keep pace with Intel and while I’m dubious of Samsung reaching 10nm before Intel, I do anticipate that both companies will ramp production of 10nm parts within the early 2017 time frame.
Through, I hate to acknowledge it, the company continues to face the conglomerate discount similar to Apple. The dependency on hardware tends to lower the visibility of business fundamentals, and while the company does have a compelling road map within mobile, I anticipate that Samsung will struggle to gain market share within the high-end. However, a pattern of market share loss is starting to emerge on the Apple front, which makes me wonder if Samsung can eventually capture some of Apple’s current installed base. It will be difficult, but the performance of handsets within the high-end are relatively similar, the key differentiator of iPhone is the software and operating system. However, Google has made steady progress at every I/O conference, which implies that Apple’s grip on the high-end could loosen given the high likelihood of iPhone price increases in emerging markets, which is something Samsung will capitalize on. After all, Samsung isn’t as aggressive with pricing recapture, therefore Samsung will be more price competitive.
The current guidance for Q1’16 implies that there will be new product releases and product mix shift to higher ASP categories thus boosting profitability. It’s not yet clear whether Samsung will deliver the Galaxy S7 in Q1’16, as many rumors indicate that the next upcoming flagship will be released at the very end of March or early April.
It’s also worth noting that Samsung will sustain OLED shipment growth in FY’16. LCD’s will likely struggle in emerging markets, but the shift to 4k will continue as pricing continues to come down. While shipments grew quite considerably in the OLED and 4K LCD LED segment, the company’s profit from that segment declined. However, I anticipate that 4K adoption will continue to tick higher throughout the year, and while seasonality will diminish QoQ gains, the YoY comps in terms of revenue and earnings should improve by mid to high-single digits.
To conclude, I walk away with the impression that a lot of the bad news has already been baked into Samsung stock. Furthermore, I think Samsung will likely exit FY’16 with revenue growth of 3% to 7%. I anticipate that silicon content gains within handsets, and mobile stabilization due to the launch of Galaxy S7 will mitigate installed base erosion.
Yes, I know much has been said about Samsung’s faltering mobile presence, but the launch of the Galaxy S7 should stifle some of the skeptics given the projected 20% improvement to battery capacity. The Galaxy S7 Edge will experience a 40% improvement to battery capacity, and Android Marshmallow will triple battery standby time. Furthermore, recent rumors indicate that the Galaxy S7 will release with a 4K display. This would not surprise me due to Samsung’s IP portfolio within display technologies and efforts to mitigate battery consumption through OLED screens.
Needless to say, the features will compound on top of each other, which gives me a small glimmer of hope. The analyst consensus doesn’t like the company as much as I do, but if there’s ever a year where Samsung can experience a recovery in the handset business, sustain momentum in display, and further penetrate into storage/memory it’s going to be in FY’16. As such, I’m forecasting 210.68 trillion ₩ in terms of revenue and EPS of 120,137₩ for FY’16. I’m initiating a price target of 1.412 million ₩, which implies 18.58% upside from current levels.
Therefore, I’m initiating a buy recommendation, as I feel the risk-to-reward is somewhat compelling given the depressed valuation and room for upside to sales and earnings.