Seeking Alpha
Profile| Send Message|
( followers)  

Samsung (OTC:SSNLF) has benefited immensely from the recent upheaval in the mobile industry and is now the most profitable company behind Apple in this space. Samsung increased its sales by ~22% in 2012, but its profit increased by an impressive 75%, due to its successful transition from low end mobile phone producer to the world's largest smart phone manufacturer. The company continued its growth in the first half of this year, with revenue growing at ~27% and profit growing at ~71% over the first half of 2012. However, a recent decline in its share price foreshadows a significant reversal of this trend.

Samsung has achieved these amazing results due to its success in the mobile business, which contributed more than two-thirds of its operating profit. Anyone following Samsung, however, should not overlook its other businesses. In Samsung's non-mobile businesses, the company holds a leading position in solid industries and has consistently increased its year-over-year operating profit for the last several quarters. To assess the fair valuation of Samsung, one must also consider its non-mobile businesses. One can certainly apply a conglomerate discount to companies like Samsung to account for an occasional misallocation of capital, lack of management focus and other issues associated with conglomerates.

Sales in USD billion

Q1

2011

Q2

2011

Q3

2011

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

CE (consumer electronics)

9.5

10.2

10.3

12.7

9.7

11.7

10.5

12.7

10.2

11.6

IMC (Mobile communication)

12.5

13.6

16.3

18.9

21.1

21.2

27.2

28.5

29.8

32.3

SM (Semiconductor)

8.4

8.4

8.6

8.4

7.3

7.8

7.9

8.7

7.8

7.9

DP (Display)

5.9

6.5

6.5

7.8

7.7

7.5

7.7

7.1

6.5

7.5

Total

36.5

39.9

42.0

48.0

41.2

43.3

47.5

51.0

48.1

52.3

Non-mobile

23.8

25.0

25.4

28.9

24.7

27.0

26.2

28.5

24.5

27.0

Operating profit in USD billion

Q1

2011

Q2

2011

Q3

2011

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

CE (consumer electronics)

0.1

0.4

0.3

0.6

0.5

0.7

0.4

0.7

0.2

0.4

IMC (Mobile communication)

1.3

1.6

2.2

2.3

3.9

3.8

5.1

4.9

5.9

6.0

SM (Semiconductor)

1.5

1.6

1.4

2.1

0.7

0.9

0.9

1.3

1.0

1.6

DP (Display)

-0.2

-0.2

-0.1

-0.2

0.3

0.6

1.1

1.0

0.7

1.0

Total

2.7

3.4

3.9

4.8

5.3

5.9

7.3

8.0

8.0

8.6

Non-mobile

1.4

1.9

1.7

2.5

1.4

2.2

2.3

3.0

1.9

3.0

Mobile business

The mobile phone industry has grown considerably in the last 5 years as a result of increasing penetration of smartphones. Lately, however, investors have been very concerned about the slowdown in the mobile phone industry and this has affected the share price of Samsung, one of the most successful companies in the smartphone business. Concerns about the mobile industry are legitimate given the increasing competition and slowing growth in the smartphone business. Despite the ongoing challenge, Samsung has been able to grow its sales and operating profit consistently for the last ten quarters in its mobile business. Samsung already controls almost one-third of the global smart phone market and it is unlikely that it will be able to increase its market share any further. But given Samsung's wide breadth of products, high marketing expenditures, improved brand position and short lead time, it is also unlikely that Samsung will lose its market share significantly. With the smart phone market still growing at a double digit rate, Samsung is very likely to maintain sales at current levels even if it loses some of its market share. Faced with increased competition from low-cost Chinese manufacturers, Samsung may have to reduce prices further, especially for their lower- and middle-end smart phones, but the Chinese manufacturers are less likely to break into the high-end handset business anytime soon. Given Samsung's currently strong position and its competitors' relatively weak situation, I think market concerns about Samsung's mobile business are overblown.

Non-mobile business

Samsung generally competes as one of the top three players in the respective industries for most of their non-mobile businesses. Notably, Samsung is the number one company in the memory, display and TV industries. Over the last few years, Samsung has invested heavily in the semiconductor business and is the second largest semiconductor company, behind only Intel (NASDAQ:INTC). With the market consolidating around three players, profitability in the memory business is expected to improve significantly. In display technology, Samsung is the global technology leader. With increasing demand for high-end displays in the last few quarters, the company - taking advantage of its technology leadership - has been able to increase its margin in the display business. In the TV business, Samsung remains the number one supplier globally. With an improving global economic outlook, demand for electronics is expected to rise in the next year and this should further improve the profitability of Samsung's display, consumer electronics and semiconductor businesses.

Operating profit margin

Q1

2011

Q2

2011

Q3

2011

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

CE

0.8%

4.2%

3.0%

4.7%

5.0%

5.7%

3.4%

5.3%

2.1%

3.4%

IMC

10.7%

11.4%

13.5%

12.2%

18.4%

17.7%

18.8%

17.4%

19.8%

18.5%

SM

17.8%

19.5%

16.7%

25.1%

9.5%

12.0%

11.7%

14.8%

12.4%

20.2%

DP

-3.5%

-3.0%

-1.3%

-2.6%

3.3%

8.6%

13.8%

14.2%

10.8%

13.7%

Total

7.4%

8.6%

9.2%

10.0%

12.9%

13.6%

15.4%

15.8%

16.6%

16.5%

Non-mobile

5.7%

7.5%

6.6%

8.6%

5.8%

8.3%

9.0%

10.4%

7.7%

11.1%

Valuation

For its non-mobile businesses, Samsung has been able to generate operating margins in the last few quarters between approximately 8 and 10%. With around $110b sales and an improving outlook for semiconductor and display businesses, we can expect Samsung to generate an operating profit of around $12b in the current year at a 10% operating profit margin. Samsung's non-mobile business is directly linked to global economic growth and can be expected to grow at a modest rate of around 3-5% in future. Due to the diverse nature of industries involved, we can expect that profit margin to stay close to these levels, even though it varies across these businesses. I will use a multiple of 12 to value non-mobile business. Though a multiple of 12 may seem quite conservative when looking at its peers in these businesses, it is a good basis for estimating valuation. With a tax rate of around 20% and a multiple of 12, we get the valuation of around $105b for Samsung's non-mobile businesses.

Company

Relevant business

P/E (TTM basis from Yahoo finance)

Intel

Semiconductor

12.2

TSMC (NYSE:TSM)

Semiconductor

14.1

Hynix (OTC:HXSCF)

Memory

15.5

LG display (NYSE:LPL)

Display

18.0

Regarding Samsung's mobile business for the current year, the company is expected to generate around $22.5b in operating profit. I think Samsung will be able to stabilize sales at the current levels in the future, though its operating profit is expected to go down due to increased competition. To make a conservative estimate here, I will use 10% operating margin for Samsung's mobile business. This margin assumption is significantly lower than the current operating margin of around 18%. Under these assumptions, Samsung will be able to generate an operating profit of around $12.5b in the future. With a multiple of 10, this will give the mobile business a valuation of around $122b. This will be equivalent to a P/E of 6.7 on 2013 earnings for its mobile business. For comparison, Apple (NASDAQ:AAPL) currently trades at ex-cash P/E of around 8.9.

To complete the valuation, we also need to consider the net cash on the company's balance sheet. Samsung has net cash of around $30b on its balance sheet. Adding all these components, I get the valuation of $257b, which is around 35% more than the current market cap of around $190b.

In this valuation exercise, I have attempted to make very conservative assumptions in regard to the multiple and future profitability. These assumptions provide me enough margin of safety for any surprises in several of its businesses, including the mobile business. But, if Samsung holds onto its current market share in the mobile business or continues to generate high operating profit, its stock will have significant upside potential. Also, with such a conservative approach, I don't need to put any conglomerate discount on this valuation.

Source: Mobile Worries Have Made Samsung A Very Attractive Investment