Samsung – Home on the range.

The value is there but Samsung is driven by earnings.

• Samsung’s Q4 was in line with estimates but I am getting increasingly concerned with its loss of momentum.
• Samsung has a window (see here) to move to the next phase of its development but the window is narrower than I had previously thought.
• Revenues / Net Income were KRW59.8bn / KRW7.3bn which missed many estimates but this has already been widely flagged and priced into the shares.
• The IT and Mobile division (which is 94% mobile) continued to be the main driver making over 50% of sales of the group and reporting 17% margins.
• This is an excellent performance given that revenues fell by 9% even though the number of devices shipped increased.
• This was due to a shift to lower end smartphones as well as an increasingly competitive landscape.
• Q1 will be a critical quarter as we will get a better view of the underlying profitability without the distorting effects of elevated marketing and employee bonuses.
• I would expect margins to rise somewhat but whether they can return to the Q3 peak of 19% is another question entirely.
• Hardware is continuing to commoditise and Samsung must make the transition into the ecosystem if it wants to sustain its current profitability.
• This means throwing Google out of its devices and enticing developers to write applications and services exclusively for its devices.
• It also means creating great services which will cause users to choose Samsung for these rather than for its great screens and cool designs which are pretty easy to replicate.
• This is a very tough proposition and despite some traction with Chat-On and interesting software innovation in the Galaxy Note, there remains a very long way to go.
• Failure to win here will mean that Samsung’s margins will begin to decline levelling out somewhere around 5-10%.
• I had thought that Samsung would have some time to address this issue but pressure is growing faster as the market runs out of growth.
• Furthermore I am concerned that the market is fragmenting meaning that more models have to be produced in order to maintain market share.
• For a company like Samsung this can be hugely detrimental to margins as R&D rises even if sales don’t move.
• This is why I am worried that earnings are not going to see any real momentum this year after a possible bump in Q1.
• Samsung is cheap but it has always been cheap and with its less than satisfactory treatment of shareholders, that is not going to change any time soon.
• Hence, the Samsung share will continue to be driven by earnings upgrades and downgrades.
• There are no upgrades on the horizon meaning that Samsung is likely to remain range bound this year.
• Microsoft, Yahoo! and Intel look like better prospects.