Samsung Electronics (OTC:SSNLF) announced a weak set of Q1 2014 results Tuesday, April 29, as revenues increased just 1.5% over the same period last year and operating profits fell slightly despite benefiting from a one-time expense adjustment. The weak performance was driven by lackluster mobile device sales, which declined 1.2% year-over-year, highlighting growing saturation at the high end of the smartphone market. This more than offset the strong recovery in the semiconductor division, since mobile constitutes over three-quarters of Samsung’s overall profits. While semiconductor sales grew 9% year-over-year, technological improvements in chipset manufacturing facilities helped operating margins improve year-over-year by over 8 percentage points to 20.8%.
We expect the trend to continue in the near term, with chipset ASPs continuing to benefit from the ongoing supply crunch brought about by years of cautious investment and consolidation. Smaller players such as Micron (NASDAQ:MU) have been active in buying out distressed rivals and optimizing factory capacity for profits. However, a gradual return to full capacity at SK Hynix following a fire at a Chinese plant in September is likely to pressure chipset prices in the near term. On the mobile front, Samsung should see the launch of Galaxy S5 bolster revenues this quarter. Taking into account the company’s increased cash balance, we have slightly revised our price estimate for Samsung to $1,450, which is about 10% ahead of the current market price. The company made no announcement on potential buybacks or dividends, but could have an update when it announces its interim dividend later this year.
Slowing Smartphone Momentum
In recent years, Samsung’s mobile division has proved invaluable in offsetting the negative business environment that its other segments have been operating in. While the semiconductor division reeled under the impact of overcapacity and pricing declines, the economic slowdown in many parts of the world reduced the demand for PCs and TVs, and therefore display panels as well. The growing demand for mobile phones, especially smartphones, and Samsung’s increasing dominance in the market served to more than make up for the weakness coming from the TV and PC side.
However, with competition increasing at the low end of the smartphone spectrum and saturation seeping in at the high end, it will be tough for Samsung to sustain its past mobile growth. Samsung has acknowledged this much, saying that it expects only a slight sequential increase in demand for smartphones and tablets in the second quarter despite the launch of Galaxy S5 in April. To be sure, the smartphone market is still expected to grow at a faster rate than the overall mobile phone market as smartphones cannibalize feature phone sales. However, most of that growth is going to come from the lower end in emerging markets, where profit margins are lower and being rapidly eaten into by rising competition. Apple’s (NASDAQ:AAPL) decision to not enter the sub-$400 smartphone market so far has mitigated some of Samsung’s near-term concerns, but the iPhone maker is facing its own growth concerns and is aggressively marketing some of its relatively lower end products such as the iPhone 5C and 4S in emerging markets (see Apple Posts Record Q1 On Strong iPhone Sales, Margin Gains).
Business Environment Improving On The Supply Side
With smartphone profits peaking, it is a good sign that the overcapacity concerns in the chipset market are decreasing and prices are recovering well after several years of contraction. In the first quarter, the semiconductor division saw its operating profits increase by over 82% as compared to the same period last year. The transition to mobile devices has created a welcome shift in mix towards mobile DRAM, thereby limiting the impact from the declining demand for PCs. However, a spurt in chipset supply last quarter after Hynix’s fire-affected Wuxi plant came back online in February caused prices to fall – a trend that we expect to continue in the near term before stabilizing. In order to offset the impact, Samsung will be looking to take market share from rivals when it begins the mass production of 20 nm DRAM, which is 40% more production-efficient than 25 nm. 
Apart from memory chipsets, Samsung also builds app processors, including its Exynos line, which is used in both the Galaxy S series and the Note phablets. The growing overall demand for smartphones and tablets should help keep sales of mobile chipsets high, allowing Samsung to benefit from this transition so long as it meets its capacity build-up targets.
- Downward Trend in DRAM Prices Likely to Continue in Q1, BusinessKorea, March 12th, 2014
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