Robust earnings at beleaguered Samsung

Korean electronics giant Samsung’s share price continues to climb. The global brand image suffered a severe knock when the company was forced to recall the Galaxy Note 7 after it was found that a manufacturing defect in the phones’ batteries had caused some of them to generate excessive heat, and catch fire.

The troubled company suffered a further blow when its vice president Lee Jae-yong was arrested and indicted on bribery charges relating to impeached former President Park Geun-hye. But despite being caught up in this maelstrom, Samsung’s share price has risen some 60% over the last year. What on earth is driving up the price of this apparently beleaguered company?

 

Earnings underpinned by semiconductor demand, despite struggling smartphone business

Source: Shutterstock

The scandal rocking Korea’s political and business elite has been widely reported in Japan, and the company has been in the news on a daily basis. All eyes have been glued to the collusive relationship between Korea’s largest family-run conglomerate and its political leadership, but meanwhile Samsung’s earnings have been robust and it has been reorganising its management in response to the Galaxy Note 7 mishap.

The interim results release reveals that 1Q (Jan-Mar) 2017 consolidated sales reached 50 trillion won and consolidated operating profits 9.9 trillion won , representing a massive 48% y-o-y growth in operating profits on sales that remained broadly flat. Whilst it will take some time for the company to rebuild its smartphone business following the Galaxy Note 7 fiasco, its earnings were underpinned by strong sales of semiconductor memory to other smartphone makers and a rise in unit price on the back of a tightening of supply and demand for DRAM, NAND and other semiconductor memory.

Forex movement provided another tailwind for earnings, as the won weakened to 1,200 won/USD at the start of the year, boosting the company’s price competitiveness.

The won is likely to weaken further in response to the geopolitical risk affecting the Korean peninsula, with President Trump going so far as to suggest the possibility of military intervention against North Korea. Whilst Samsung’s business could hardly be immune to an actual attack on North Korea, the heightened tension is a positive for the company in so far as it undermines the value of the won.

 

Emerging hopes for “chaebol” reform

The Korean economy has been driven by the five big “chaebol” family-run industrial conglomerates – Samsung, Hyundai Motor Company, SK, LG and Lotte. Following the devastation caused by the Korean War in the 1950s, these conglomerates have spearheaded growth in the Korean economy since the 1960s, and it is now among the leading economies.

According to World Bank data, in 2015 Korea’s GDP was US$1.38 trillion. Samsung generated sales of 200.65 trillion won that year. Calculating on the basis of an exchange rate of 1,000 won/USD, Samsung alone accounts for around 20% of the nation’s GDP. The Korean economy is heavily dependent on the five big “chaebol” conglomerates, and the severe damage caused by the fact that they remain family-run businesses and the adverse impact this has on the Korean economy is frequently highlighted.

The fact that the arrest and indictment of Lee Jae-yong has laid bare the collusive relationship between Korea’s largest industrial group and its preeminent political leader has raised hopes that the Korean government will make a long-overdue concerted effort to force reform on the conglomerates which so dominate the economy.

Samsung could rationalise its management by becoming a holding company, but this is unlikely to happen given the significant obstacles to such a move.

Samsung’s share price fell from its closing price on the eve of the day its de facto chief Lee Jae-yong was arrested in mid-February, but it did not lose much ground, resumed its rise in March, and continues to climb after topping the 2mn won mark.

This share price movement suggests that investors’ unease that the de facto chief is no longer at the helm is outweighed by their hope that Samsung will reorganise its management. Samsung’s share price is also benefiting from the fact that rival companies are making little headway. Toshiba (6502), whose management has been thrown into crisis by huge losses in its nuclear power business, was snapping at Samsung’s heels in the semiconductor DRAM and NAND businesses, but has been forced to hive off its semiconductor memory business in a bid to secure new capital.

Meanwhile, Samsung, whose semiconductor business remains robust, has announced a new smartphone model, the Galaxy S8. Since the battery defect in the previous model damaged the company’s business, it will be looking to the new model to restore its reputation in the smartphone market. Recovery in smartphone sales would give further impetus to expectations of share price rise.

With its semiconductor operation generating solid earnings, a weaker won on the back of geopolitical risk in the Korean peninsula and rising expectations of management reorganisation following the Lee scandal, we cannot afford to take our eyes off Samsung’s share price.

(By ZUU)

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